Escolar Documentos
Profissional Documentos
Cultura Documentos
Officers (B is an officer)
Employees (B is an employee)
Could be setup as an S corporation, (type that is not taxed twice).
(d) Limited Liability Company? Isn’t because you have to file. But if you set
it up properly, then this has the most flexibility than any other (look and act
like a partnership, but have benefits of corporation)
(e) Partnership: If a driver is added to this hypo, then an employee is added
and he is a servant to the partnership. The employee can be held liable
for what the servant does, within the scope of his duties. (i.e. driving a
truck and causing an accident – partnership would be liable for
negligence). Apparent or actual authority is the question. The share of
profit and loss are 50-50 (no matter what you contribute) unless you agree
otherwise. What is a fair split? Losses, the business loses money, then
the partners are all jointly and severally liable for obligations of the
partnership. If one partner pays for all liability, the partnership is still liable,
so the partnership must indemnify partners, for costs and losses incurred
during the business. The problem is the partnership is broke. The assets
of the partnership include contributions that the partners must make to pay
off the partnership debts. Therefore, the partnership owes one of the
partners for the losses paid for by the partner minus his % of that debt.
Class Example: A owns 20% of the profits and losses in a partnership, B is 20%
and C is 60%. The partnership owes $8,000. A is bankrupt. You must split ¼
(B) and ¾ (C) of the $8,000. The whole amount must be covered.
A contract that agrees to cover liability between partners, this only
includes the partners. Partners are still servally and jointly liable,
therefore, 3rd persons can sue no matter what the partner’s agreement is.
(f) Limited Liability Partnership: Many states don’t allow professionals to be
in partnerships. Most law firms are partnerships. Therefore law partners
up to this point each partner was severally and jointly liable. To avoid this
Texas set up partnerships with the difference that says: Partners are not
liable for tort claims against the partnership. Everyone is liable for their
own torts (malpractice). Partners therefore are not jointly and severally
liable. 30 states have allowed this. Some states have added contractual
claims as well. People are liable for their own wrong doings. A
partnership is liable for its own assets, then the wrong doing partner
comes next.
2) Agency Law
(a) Principal-agent: An agency is a fiduciary relationship that results from
consent between the principal and agent that the agent shall act on the
principal’s behalf and subject to her control (Rest. 2nd of Agency §§1, 2)
(b) Master-servant: A master is a principal who employs an agent to perform
service in her affairs and who controls or has the right to control the
physical conduct of the other in the performance of the service
(c) Independent contractor: is a person who contracts with another to do
something for her, but who is not controlled by the other’s right to control
with respect to his physical conduct in the performance of the undertaking.
The independent contractor may or may not be an agent.
(d) Questions: In the above situation, has a principal-agent relationship been
established? An employer-employee relationship? An independent
contractor relationship? Alternatively, are A and B partners? Is A a limited
partner? Can A get what she wants if she organizes as a corporation?
5. The Corporation as a “Person”
Continuum of Business
Sole Proprietorship/Partnership Corporations
Joint & Several Liability Limited Liability
No Tax (except personal) (Corp. and personal tax)
1) Limited liability
2) No tax
3)
4)
Rules for Partnership
Look to the Rules of Agency
C) Management: All partners have equal rights in management (even if sharing
of profits is unequal)
(a) Partner is an agent of the partnership: Gives them the power to act on
the behalf of another (this is a limited authority)
(b) Determination of agency
(1) Actual authority: Explicitly given
(2) Apparent authority: When you are acting outside the authority
given. (create impression that authority is there). This is done
through
(i) Custom (even no actual authority the impression is you have it)
Was this reliance unreasonable? If no, can the 3rd party go after
the partnership.
(ii) Course of dealings: This creates the impression of authority
To avoid apparent authority problems, then put the suppliers on notice, that there
is no authority.
NOTE: PARTNERSHIP VOTE IS A HEAD COUNT, NOT INTEREST OWNED,
UNLESS THE PARTNERSHIP AGREES OTHERWISE. THEREFORE: IF 3
PAR
REVIEW
FANARAS ENTERPRISES, INC. v. DOANE (423 Mass. 121)(1996)( (p. 52)
D) Duties of Partners to Each Other: The duty of one partner to all others is
based on a fiduciary relationship.
********************************************************************************************
Formula for Partners Accounts
PARTNERS ACCOUNT = (CONTRIBUTIONS-DISTRIBUTIONS) + (PROFITS – LOSSES)
When a partnership is dissolved, all partner accounts must equal zero
Income Statement
Death of a partner: On the death of a partner, the surviving partners are entitled
to possession of the partnership assets and are charged with winding up the
partnership affairs w/o delay. (UPA §37). The surviving partners are charged
with a fiduciary duty in liquidating the partnership and must account to the estate
of the deceased partner for the value of the decedent’s interest.
Cauble v. Handler (1973) (p. 78)
Facts: Cauble and Handler (D) were equal partners in a retail furniture and
appliance business. Cauble eventually died, and the administratrix (P) of his
estate sued Handler (D) for an accounting of the partnership’s assets. After
receiving the report of a court appointed auditor, the trial judge awarded Cauble’s
administratrix (P) $20.95 and some interest. He then taxed the entire $1800 in
auditor’s fees to the administratrix (P). She appealed, claiming that the court
should have used market value rather than cost in appraising the existing
partnership assets and that the court should have awarded her half of the more
than $40,000 that Handler (D) had earned in profits by continuing to operate the
partnership’s business after Cauble’s death.
Issue: Does the non-continuing partner have a right to share in the profits
earned by a partnership after the date of its formal dissolution?
Rule: If a partnership continues to do business after it has been formally
dissolved, the non-continuing partner or his representative may elect to receive
his share of the profits earned by the firm after the date of its dissolution.
Analysis: The trial court did err in computing the worth o the partnership assets
by their book value rather than their market value. But, of far greater moment
was the court’s erroneous refusal to award ½ of the profits which Handler (D)
earned after the partnership was dissolved by Cauble’s death. When Handler
(D) continued to operate the business after Cauble died, the administratrix (P)
had several choices. She could have insisted on liquidation, which would have
entitled her to 50% of the proceeds of the sale of all partnership property.
Instead, she permitted the business to continue. She thus became eligible to
receive the value of Cauble’s interest as of the date of dissolution. And
according to § 42 of the Uniform Partnership Act, she also had the right to elect
to receive a share of the profits from the continuing business. There is no
question but that she exercised that right at or before trial. The judgment must
be reversed and a new trial held, at which the court might also reconsider the
decision to charge the entire auditor’s fee to the administratrix (P).
Comment:: Cauble v. Handler describes in detail the options which are available
to a non-continuing partner or his personal representative upon the dissolution of
partnership. The various rights which may be exercised if the partnership
continues in operation after the dissolution are of increasing importance. This is
because dissolutions today only rarely result in the cessation of business.
Illegality: Dissolution results from any event making it unlawful for the partnership
to continue in business.
June 1 Assignment
4 things that the IRS looked at
Corporation: If you have 3 or 4 you are seen as a corporation
Partnership: 2 or less
Hypo #1: Corporation is General Partner of limited partnerships. Who does the
Board of Directors have a fiduciary responsibility to? The Shareholders of the
Corporation or the Limited Partners of the Partnership?
C) The Limited Liability Company: Between 1988 and 1997, every state
adopted LLC statutes that authorizes the creation of a new business form, the
“limited liability company” LLC.
(1) LLC is an unincorporated business organization that contains dissolution,
management and transferability provisions similar to those of a general
partnership but that can easily be altered to resemble the limited
partnership or to approach the corporate model.
(2) By combining the best of both worlds the tax advantages of a partnership
with limited liability protection for all members (usually associated with
corporations) the LLC can be seen as tax driven.
(3) LLC members unlike general partners, can adopt a management
structure resembling those of corporations or LLPs by appointing
managers. LLC managers, hold the power to make important policy
decisions and to bind the LLC in day to day business transactions This
takes on the role of general partners and corporate directors and officers)
(a) Scope of liability:
(b) 2 member requirement:
(c) Piercing the veil:
Poore v. Fox Hollow Enterprises (1994) (p. 140)
Issue: LLC is not a corporation, does a licensed attorney have to represent the
LLC in court?
Rule: The underlying purpose of the rule prohibiting the appearance of a
corporation by anyone other than a member of the Delaware Bar also apples to
the representation of LLCs.
Comment:: LLC is an artificial entity, like a corporation, and therefore an agent
must represent it. With this in mind the statute states that a member of the
Delaware Bar must represent the LLC
Types of Taxation
(a) Corporate Tax Rates (p. 145) (Top effective rate is 35%)
(1) C Corporation: Taxed once, and if they keep the money no more tax.
However if dividends are paid, individuals must pay tax on the dividend
only on the amount that is distributed.
(2) S Corporation:
(3) Personal Services Corporations: Taxed at a flat 35%.
(b) Individual Tax Rates (p. 146) (Top effective rate is 39%) Tax on what you
earn. (Proprietorship, Partnership (problem is that the partnership can
keep the money, but income tax must be paid no matter what was
distributed to you)
Regressive Tax System: (Sales taxes are naturally regressive) Tax affects those
with a lower income more. (Flat tax on all types of income is not that way)
Tax planning strategies (p. 153) Tax is the biggest areas to determine a
business form
(1) Don’t pay dividends if you are a C-Corporation: This way the corporation only
pays taxes, not double taxation on the dividends. When company reaches a
certain size, sell the stock; get capital gain and pay capital gain tax 1x.
Downside is more shareholders come in. instead:
(2) Corporation can buy stock back from you (Corporation redeems stock), and
the same takes place.
(3) Avoid corporation: Form an LLC
(4) Zero out: Make the corporation not have any income. Revenues – Expense
= Zero. Increase expenses to do this. Most popular expense to increase is
salaries (Big Bonus). Eat up a lot of profits. Individual taxes are paid, and
avoid corporate taxes. (e.g. rent to corp. land, take a loan from corp.) This is
OK as long as it is reasonable for that type of business. This is OK if
reasonable.
(5) Losses: If they are expected, it is common to start out with an entity which is
not taxed immediately, then convert to a corporation, which has the tax
barrier. There are now more restrictions on losses taken.
Sub Chapter S Corporation: Just like a normal corporation, but the exceptions
are:
(1) Make a special filing to the IRS that you want to be treated like an S Corp
(2) Essential the individual is taxed, not the corporation
(3) Technically taxed slightly different
(4) Everyone does not choose this because
(a) You are limited to 75 shareholders
(b) Can’t have any non resident aliens as shareholders
(c) Couldn’t have a corporation or other entities as a shareholder (until 1997).
(d) Can only have one class of stock..
(e) Cannot own a controlling interest in another corporation and most other
types of entities.
S-Corp v. LLC: LLC gives pass through tax treatment and limited liability.
(1) Continuity of life
(2) Centralized management*
(3) Limited liability*
(4) Flow through treatment of a partnership (tax treatment)*
Create an entity with limited liability, with 2 other of the 4 criteria the IRS
came up, and create a new entity taxed as a partnership. This gives the best
of both worlds. There is uncertainty with LLC’s.
Some people take S-Corp because creating it is very simple, formal, well
defined, and there is plenty of case law.
LLC will probably grow to be the entity of choice.
LLC kills the 4 criteria test of whether you are a partnership v. a corporation.
1/1/97 new regulations
Limited Liability Company: These entities existed before check the box. Each
state handled this a little different. Model either on corporate or partnership
statutes. LLCs can be any where in between. Tremendous flexibility.
Terminology used
Members: These are the same as shareholders in Corporations and partners
in partnerships.
Agency type authority is given to members (any member can bind the entity).
This can be changed according to statutes, or if modified in the agreement.
Governing structure is more like a partnership (do a head count vote) You
don’t vote as % of ownership or number of shares unless you modifiy you
articles of association. (Some states look at profit pd to each member)
Manager managed: Usually authority comes from a hierarchy of manager
managed v. member managed. This is a hierarchy similar to t Board of
Directors.
Members are not liable for the wrongful acts of other members, only your own
acts. Limited liability for business debts, but excessive distribution must be
paid back by individual members.
Most states require 2 members
Default is that unanimous vote by all members to bring in a new member,
unless the power is delegated to the managers.
Must say in the name of the LLC that they are an LLC (Notice concept)
Ultimate governing document in a corporation is the articles of corporation
and then the By-laws. If there is a conflict the Articles are controlling.
LLCs have Articles of organization. Operating agreement (like the By-laws)
The operating agreement is controlling in an LLC.
Some states discourage LLCs by charging higher fees for formation and
having franchise taxes imposed on them.
EXAM PREPARATION
2 questions on corporate law
1 question on think piece (Business Planning) MOST OF THIS HAS BEEN
DISCUSSED
Show the understanding of pros and cons of business planning
IV) Formation of a Closely Held Corporation (pp. 194-249)
A) Where to Incorporate
(1) What does it cost to incorporate
How much does it cost to keep the corporation in that state?
Where will you be doing business? You have to be registered in
that state that you do business regularly. You pay a fee for this as well.
Looking at costs, Delaware has been a major choice, and look at
your home state.
If you incorporate in Delaware and do business in Ohio you will
probably have to pay fees in both states
(2) Where are the state laws favorable for the corporation?
Belief is that the advantage is in Delaware
Look at the practical considerations to compare
Publicly traded v. closely held: Most closely held are incorporated
in the state they operate
(3) Delaware
More expensive, hire attorneys
Taxes in Delaware and where you do business
B) How to Incorporate
(1) What do you need to do?
Reserve your name (before you setup the corporation)
File Articles of Incorporation (some states have an actual form to
use. This basically says
(a) Name of corporation
(b) # of authorized shares (if you change this you must amend the articles)
(c) Appointment of agent (so process can be served) & a registered office
(this is usually done by a special organization or attorney)
(d) Name and address of the incorporators (not necessarily the Board of
Directors)
(e) Must be signed by the incorporator and the initial directors (indicate
your capacity)
Ultra Vires Acts: literally means “beyond the powers.” When a corporation does
an act or enters into a contract beyond the scope of its charter, it is not
necessarily illegal and it is not necessarily void. Rather, it is voidable. The
doctrine of ultra vires is declining in importance and should not be applied to
purposes clauses of articles of incorporation. When you limit your purposes or
powers this act comes in to play.
English case: Ashbury Railway Cartage & Iron Co. v. Riche (1875), the
discussion surrounded the question of a contract’s being void from the beginning
because the object of the contract was beyond the powers of the corporation.
The corporation was allowed to repudiate a contract on the ground of ultra vires
after it had partially performed
Arguments for Ultra Vires: The limits of power are public record, caveat emptor.
Arguments against Ultra Vires: A corporation can injure others without any
repercussions. 20th Century courts did not like this so they made arguments of
estoppel, unjust enrichment, waiver, etc.
711 Kings Highway Corp. v. F.I.M.’s Marine Repair Serv., Inc. (1966)(p. 215)
Facts: 711 (P) leased premises to F.I.M. (D) for use as a move theater for 15
years. F.I.M. (D) paid a $5,000 security deposit. 711 (P) then tried to get a
declaratory judgment declaring the lease to be invalid or, in the alternative,
rescission on the grounds that the intended use was outside the scope of
permissible business activities under F.I.M.’s (D) charter. F.I.M. (D) moved to
dismiss arguing that only a shareholder could assert the claim brought by 711
(P).
Issue: Should a no act of a corporation and no transfer of property to or by a
corporation, otherwise lawful, be held by reason that the corporation was w/o
capacity or power to do such act or engage in such transfer except in an action
brought by a shareholder?
Rule: Yes. No act of a corporation and no transfer of property to or by a
corporation, otherwise lawful, shall be held invalid by reason that the corporation
was w/o capacity or power to do such act or engage in such transfer except in an
action brought by a shareholder.
Analysis: This also includes actions taken by or in the right of a corporation
against an incumbent or former officer or director. Clearly, under this rule, there
was no substance to 711’s (P) argument as 711 (P) did not fall under either
exception. Nor could 711 (P) escape application of the rule by claiming that it did
not apply to executory contracts. Complaint dismissed.
Comment:: Ultra Vires literally means “beyond the powers.” When a corporation
does an act or enters into a contract beyond the scope of its charter, it is not
necessarily illegal and it is not necessarily void. Rather, it is voidable. However,
under the English case: Ashbury Railway Cartage & Iron Co. v. Riche (1875),
the discussion surrounded the question of a contract’s being void from the
beginning because the object of the contract was beyond the powers of the
corporation. The corporation was allowed to repudiate a contract on the ground
of ultra vires after it had partially performed. However, the doctrine of ultra vires
is declining in importance and should not be applied to purposes clauses of
articles of incorporation.
Ultra Vires is dead, Charitable giving is OK. Charitable giving was raised to 10%
by Reagan. Most corporations give 1%.
June 10, 1998 Class Starts Here
1. Pre-incorporation Promotion
a) General rule: a person signing for a nonexistent corporation is
personally liable unless there is clear intent expressed to the
contrary: (Do the parties know it’s pre-incorporation or think the
corporation is already set up)
(1) Thus, when person signs contract for architectural services
as “agent for a corporation to be formed who will be the
obligor,” that person is liable if the corporation is never
formed. (Stanley J. How & Assoc. v. Boss)
Promoters are personally liable, unless one of the following are agreed to by the
other party:
(a) Contract w/ promoter and other company if corporation
accepts promoter and corporation on the hook.
(b) Revocable offer Future Corporation (if corporation
formed and accepts K)
(c) Irrevocable offer consideration is that promoter
formed the K corporation accepts with liability being
released to corporation (when formed)
(2) The upshot is that you must make it expressly clear that the
individual isn’t to be liable
b) Cover Your Ass (CYA)! – get copies of the stamped, filed
incorporation document before closing anything!
c) Restatement (2d) of Agency §326, comment b: Intent can be
shown by a revocable offer, offer made irrevocable for a limited
time with promoter’s implied promise to use best efforts to
incorporate, etc.
d) At the end of the day, though, any ambiguity is held against
the agent
e) Clarity in signature of contract: Who are you, President of the
Corporation or an individual
Correct Signature: ABC Corp, by DBMcDonagh, President
Incorrect Signature:
ABC Corp.,
signature and corporate seal (you’ll be liable) or
or
ABC Corp,
By DBMcDonagh, President,
DBMcdonagh (w or w/o President) This shows that you intended to be liable
personally.)
pr
ABC Corp,
signature, Authorized
signature. (corp probably not bound and personally bound)
Fact based inquiry, based on intent, be very clear if the entity is not formed (that
they will not go after the promoter if the corporation is not formed)
Accepting the product or service that was contracted for by the promoter,
is acquiescence to the contract.
2) Defective Incorporations
De Jure corporations is one which as been created and recognized in
compliance with the general incorporation law of the particular state (few
corporations are chartered by Congress and only in extraordinary circumstances
such as the Red Cross). This usually means literal compliance with all mandatory
incorporation requirements and substantial compliance with all directory (where
court has discretion) requirements.
De Facto corporation (Good Faith attempt to incorporate) is one where
sufficient steps have been taken toward incorporation for a court to be justified in
finding that the association involved was “in fact” operating as a corporation.
Such a finding raises the association’s status to that of a de jure corporation
against all persons except the state (who may have the corporation declared
invalid in a so-called quo warranto proceeding).
(A) Thus, where a corporation has filed, paid taxes, but had a few errors in its
incorporation process, it is a corporation for purposes of determining the
order of payment to creditors. (Matter of Whatley) Court sets out three
factors for a de facto corporation:
(a) Existence of a valid law under which it could incorporate
(b) Bona fide attempt to incorporate
(c) Actual use of corporate powers
Incorporation by Estoppel is an equitable theory invoked by courts to avoid
injury due to detrimental reliance upon someone’s representations, etc.
(A) Sometimes, a court will treat a corporation as formed even though there are
technical defects.
(B) Also, where attorney botches incorporation, individual s/h still retain limited
liability so long as
(1) creditor thought it was a corporation at time of contract and
(2) investor in good faith thought a corporation had been formed
(i.e., reasonable reliance on the attorney) (Cranson v. IBM)
Effect of this: so long as investor had good-faith reliance, there is no liability for
transactions (but liability remains for torts)
EXAM KEYS
Reviewing piercing the corporate veil, the factors to look at in determining
this are:
1) Corporation Formalities (Were meetings, etc setup)
2) Control / Domination of the Company (Was there control of the
company by the shareholders?)
3) Under-capitalization (was there enough money in the corporation to
operate?) This should be the philosophical reason to pierce, however
most courts look at lack of corporate formalities)
4) Alter Ego/Instrumentality: Was this an alter ego of the shareholders or
an instrumentality of some other entity to completely avoid liability.
Key difference between this and contracts: the injured party here is not a willing
party
1. The veil will not be pierced just because the plaintiff cannot recover
solely from the corporation – must prove control and bad conduct
a) Thus, in Walkovszky v. Carlton, 2-cab corporation will not be
pierced even where sole s/h owns 9 other 2-cab corporations
just like it. Why? Because the corporation was incorporated in
perfectly legal fashion, and the fact that there are multiple
entities does not constitute a fraud.
(1) Also note dicta saying that undercapitalization argument fails
as well – the cabs carried the requisite amount of insurance
mandated by law ($10,000); since the legislature says that
amount is sufficient, the courts presume it is not
undercapitalized.
(2) To even state a cause of action that can be heard, plaintiff
must allege the business was run in a “personal capacity”
b) Also see Radaszewski v. Telecom Corp., where piercing was
denied where corporation was thinly capitalized and went
bankrupt but nonetheless carried adequate liability insurance
coverage. The court says no socially irresponsible behavior
here.
(1) Court sets following test for piercing:
(a) Complete shareholder control of corporate policy with
respect to the issue at hand
(b) Used to commit a fraud or wrong (i.e., breach of duty –
no such breach here because of adequate insurance)
(c) Injury to plaintiff
(2) Dissent: insurance isn’t per se adequate capitalization;
question should be submitted to a jury
A) However, can’t defend yourself on the grounds that you were a ‘temporary’
director (Minton v. Cavaney)
B) Mere opportunity to control isn’t enough – must be actual utilization of control
(American Trading and Production Corp. v. Fishbach & Moore)
C) However, a family-owned corporation with subsidiaries where the parent
corporation totally dominates the subsidiaries to the extent that it’s unclear to
a neutral observer that they are separate entities can result in piercing. (My
Bread Baking Co. v. Cumberland Farms, where it was shown that president
directly ordered subsidiary to not return bread racks)
In other words, a jury could reasonably find the subsidiary was a
mere instrumentality of the parent – so the issue of control should reach a
jury.
EXAM: 4 Questions
1) 1 Question: be a business planning question and you need to advise
them as to the type of entity of what they use and the pros and cons of
all the entities that could be used) 25 Points
2) 2 Heavy fact pattern questions: will be geared around liability and
anytime something wrong occurs and what will 65 points: Not looking
for a great essay, look for the issues and discuss briefly and with
default setting, problem, and what the situation really is. (i.e. Rule,
violation, move on, good faith effort to comply, what is the minority rule.
3) 1 Question: a think piece, (i.e. Should the sole duty of directors be to the
shareholders?) discuss all valid points in this area (15 points)
(a) 4 hours: can be taken anytime and can be checked out at the
registrar desk and make arrangements to turn it back in.
(b) Grading: Check for technical compliance (over time ?)
Was the exam initialed, typed or in pen?
Grade Question by Question
(c) Will grade at the end of the exam time.
4) He will administer exam the night it is scheduled for.
5) You can use word processor, do not download pages out of outline;
(a) Positive points for every problem found.
(b) Negative points for problems that are not really there.
6) Consult anything other than a person. Do not discuss the exam with
anyone.
7) Double space, don’t scribble.
8) Will schedule a night during the reading period, where he will go
through the exam he used previously.
9) Pre-take the exam.
Regulation D – Rules Governing the Limited Offer and Sale of Securities without
Registration Under the Securities Act of 1933 (17 CFR §230.501)(1997)(p. 342)
TEST FOR A SECURITY: Essential managerial efforts which affect the failure or
success of the enterprise are what is meant by efforts of others. A security exists
when:
(A) An investment is involved;
(B) in a common enterprise; (in this case they said there was a
symbiotic relationship between the companies)
(C) with profits to come solely from the efforts of others.
(meaning the efforts made by those other than the investor are the
undeniably significant ones.) (In the above case the profit would
come solely from the brilliant efforts of Gross).
Balance Sheet Test: dividends may only be paid when (after the payment of the
dividend) the assets exceed both the liabilities and the capital stock accounts.
Earned Surplus Test: Indicates that dividends can only be paid out of the
earned surplus (including current profits) of the corporation.
Solvency Test: The corporation cannot pay a dividend if it is insolvent or the
dividend would make it insolvent. Definition of insolvency include:
(a) Liabilities exceed assets.
(b) The company cannot meet its debts as they fall due
(regardless whether the value of the assets exceeds the
liabilities)
In some states, amending the by laws is allowed by the board. Most state
statutes said this specifically, but the modern approach lets the Board or the
Shareholders amend by laws unless the Articles of Incorporation gives this only
to one group (not usual)
The above case shot down McQuade if you are a closed corporation.
If you don’t act unanimously at the outset or you are not a closed corporation,
you can’t get rid of the powers of the directors v. shareholders.
McQuade is good law for
1) Large Public corporation
2) In state where you have to action to be known as a closed corporation.
3) May apply where you try to cram something down a minority’s throat
Shareholders vote to
1) elect and remove directors.
2) amend by-laws.
3) Approve mergers and assets sales not in the normal course of business
(i.e. mergers, dissolutions, conflict of interest transactions – member of the
board is dealing with the company and may be doing things for his personal
gains; indemnification of director or officer; make recommendations i.e.
authorize dividends; and appoint the auditors.
A. General Concepts: S/holdrs can only act at reg. mtg (OHIO unanimous
written consent)
-> Must have annual mtg; special s/holdrs mtgs can be called by dir.,
Pres. or usually 25% s/holdrs (ltd to items in mtg notice); quorum is
maj. of authorized & issued record s/holdrs entitled to vote
Shareholder Meetings
A) Annual Meeting
1) Shareholders vote on various items affecting the corporation
B) Notice varies from state to state, 10 days to 50 days. If notice is not sent and
any one objects the meeting cannot proceed. If waived then meeting can
proceed.
C) The more common way of a meeting to happening is that if you showed up to
the meeting and didn’t complain about getting notice then you have
acquiesced to the meeting.
D) Quorum: is needed, and this is decided by the by laws. Normally it is a
majority of issued shares. What happens if at a meeting there are 500 shares
in a company and 251 shares show up and I own 3 shares. If the person with
3 shares walks out of the room, the meeting keeps going. You cannot walk
out of a meeting to break a quorum.
E) The number of votes needed to pass corporate activities are listed in the
Articles of Incorporations is typically a majority of shares at the meeting.
Traditionally you count abstentia votes as a no. Under the MBCA you don’t
count abstentias. (so only those actually vote count).
F) We don’t want to have a meeting we can sign an unanimous letter (everyone
must sign) so that no meeting need to be held. (this is in some states, other
states say that you need a majority to pass a resolution.)
G) The company, in the notice, states a record date in the notice that is when
they are going to look in the corporate books to see who the shareholders
are. This determines who can vote.
H) Beneficial ownership (has the right to dividends and the right to vote) is the
stock issued to Cede & Company ( a nominee who is the record holder on the
books) This company has to notify the (beneficial owner who can vote (in
some case, if you don’t vote the record holder may be able to vote in your
place.) Dividends are paid to Cede & Co. who then pays the dividends to the
beneficial owner.
I) The record owner has an obligation to notify the beneficial owners on all
activity of the stock. Most public companies contact the record holder.
J) When the meeting is held, the record holder is sent a proxy, who forwards
the proxy to the beneficial owner, with the notice of the meeting and
beneficial owner sends it back to them with how they want to vote (in some
cases the record holder may have the right to vote).
5 person board
125 Total Votes 121 1 1 1 1 (minority) would get one spot
375 Total Votes 75 75 75 75 75
Ling and Co. v. Trinity Sav. and Loan Ass’n (1972)(p. 470)
RESTRAINT ON ALIENATION OF SHARES
Facts: be obtained from the New York Stock Exchange before any sale. The
limitation requiring an offering to other shareholders of the same class appeared
on the stock certificate but was not in bold type or otherwise conspicuous. The
lower court entered summary judgement for P, and the state circuit court of
appeals affirmed.
Issues: Were the restrictions on the transfer of the stock valid?
Rules: Yes. Reversed.
1) Although the state law of forum generally requires restriction to be
conspicuously noted on the certificate, if P is aware of the restrictions
conspicuous notice on the certificate is not required. Summary judgement for
P should not be granted w/o conclusive proof that P lacked notice of the
restrictions on transfer.
2) Both restrictions are reasonable since allowing shareholders of the same
class to purchase before a public sale has not been shown to be unduly
burdensome, and the approval of the New York Stock Exchange was required
by the exchange while Ling was a member.
Rule of construction: relating to restraint is that they are construed narrowly so
as to give maximum scope to the ability of the shareholder to transfer the shares.
B. Judicial Dissolution
1. S.Ct. or Ct. App. order to wind up corporate affairs for misuse or
nonuse of corporate powers
2. Common Pleas order to dissolve after s/holdrs entitled to dissolve
voluntarily establish:
a. Art. were cancelled or corporate existence period up &
dissolution necessary to protect s/holdrs
b. corp. insolvent/unstable & necessary to dissolve to protect
creditors, or
c. corporate objectvs have failed, been abandoned or are
impracticable to accomplish
3. By Common Pleas order if bet. MAJ & 2/3 (if 2/3 could voluntarily
dissolve) show beneficial to s/holdrs to dissolve
4. By Common Pleas order after either 1/2 Dir. or s/holdrs 1/2 of
voting power show dir. even #, hopelessly deadlocked in mgmt of corptn &
s/holdrs can't break deadlock so dissolutn only answer OR dir. uneven #
but s/holdrs hopelessly deadlocked in electg directors (DISSOLUTION HERE
CANNOT BE DENIED JUST B/C CORP. SOLVENT OR PROFITABLE)
5. By Common Pleas order after prosecutor shows corp. organized and
used to further criminal purposes
E) Action by Directors (p. 504) The general rule is that the board must act as
a board, by resolution or vote at properly called meetings, at which
there is a quorum, or in some way approved by state law as an
alternative (i.e. by unanimous written consent), in order for an action by
the board to be valid.
Baldwin v. Canfield (1879)(p. 504)
FORMAL BOARD ACTION REQUIRED
Facts: King owned all the stock in a corporation. He pledged the stock for a
loan, partly to a bank and partly to Baldwin (P). The corporation’s only asset was
a piece of real property. King then agreed to sell Canfield (D) the property for
some bonds and a note. D knew about the corporation, but he did not know
about he pledge of its stock to P. King agreed with P to liquidate the loans with
the consideration received from the sale of the corporate property to D, but he
never did. King gave D a deed from the corporation (signed by some of the
directors). No directors’ meeting was ever held to authorize the sale of the
property. The pledgees (Baldwin) of the stock sued King and D to cancel the
sale.
Issues: When a board of directors acts separately and without a meeting in
passing a resolution, will the board’s actions be upheld?
Rules: No Judgement for P.
1) Title to property was in the corporation. The deed given by King was a valid
conveyance to D. Directors must act as a board; the separate action
individually of members of the board does not constitute official board
action. Hence, the directors never took action with reference to the sale
of the property, and the deed is ineffective since board action is
required in this transaction.
2) D has an equitable interest in the land, subject to the interest of the pledgees.
Comment:: Most states allow corporate action where all directors consent
in writing to the action, even if a meeting is not held. (some states don’t
require unanimous consent)
WHEN CAN A BOARD BE BOUND?: The simple concept is that the board can
be bound by 1) formal adoption of a resolution (before the action); 2) ratification
of the resolution (after the fact) or 2) resolution by acquiescence
Board (No day to day decisions – appoint officers, have duty to the corporation
and the shareholders)
Officers (make the ongoing decisions – sign the paper work. Make day to day
contracts) Have duties to shareholders and corporation.
Authority:
Implied and Inherent authority of the officers.
MBCA 8.01
KEY: Check the scope of the authority of the person you are contracting with
(what does the statute say, and what do the (up to date) by-laws say. The
secretary can certify the accuracy of the by laws)
Authority has been broadened, because the layman has a reasonable
expectation that the president has more power.
Officers of a company:
President: has the authority to sign things in the “usual and ordinary course of
business” and presides over meetings
VP: delegated authority of the president
Treasurer: Keeps the funds
Secretary: Keeps minutes, stock transfer book, sends out notices, and co-signs
with the president when needed.
A corporation must have 2 different people as officers.
Duty of Care and the Business Judgement Rule (pp 663-752) By law,
directors have the duty of management of the corporation. This duty is normally
delegated to the officers, thus, the directors must supervise the officers. The
legal duties of the directors and officers are owed to the corporation;
performance of these duties is enforceable by an action on behalf of the
corporation brought by an individual shareholder (called a “derivative suit”).
1) Fiduciary relationship of directors to the corporation
a) Duty of loyalty or good faith
b) Duty of reasonable care
c) Business judgement
(1) A different standard of care would apply to directors and to
officers (i..e. if there is a more limited role for directors then
negligence is failure to perform with care expected of a
director, but not necessarily failure to perform with the
prudence that a director would give his own personal
business dealings).
(2) Business Judgement Rule: where a matter of business
judgement is involved the directors meet their responsibility
of reasonable care and diligence if they exercise an honest,
good-faith, unbiased judgement. Where this standard is
applied, a director would only be liable (if his actions were in
good faith) if he were guilty of gross negligence or worse.
2) Damages: To form a cause of action, it must be shown that the director or
officer failed to exercise reasonable care and that as a direct and proximate
res ult the corporation has suffered damages.
a) Joint and several liability: Either one director may be held liable for his
own acts, or all directors may be held liable (all those participating in the
negligent act.) Where more than one director is held responsible liability is
joint and several.
Litwin v. Allen (1940)(p. 663)
DUTY OF CARE OWED BY BANK DIRECTORS
Facts: A shareholder (P) brought a derivative action against the directors of
Guaranty Trust and it’s wholly owned subsidiary (the Guaranty Company). The
Trust Company purchased some bonds from Alleghany Corporation (J.P. Morgan
is the broker) and gave an option to Alleghany to repurchase them in 6 months
for the same price. If Alleghany did not repurchase, the subsidiary (Guaranty
Company) was obligated to purchase the bonds at the same price from the Trust
Company. Alleghany could not get a loan, and so the subsidiary bought the
bonds at $105 (market value was then in the $80’s). The bonds subsequently
dropped drastically in price, and the Guaranty Company lost substantial amounts
of money.
Issue: Has there been a violation of the director’s duty of due care in entering the
transaction with Allegheny Corporation?
Rule: Yes. Judgement for P.
1) The duty of due care is higher for bank directors than for other companies
since banks are affected with the public interest. Thus, bank directors must
exercise the care of “reasonably prudent bankers.”
2) The purchase by Guaranty subject to the option to buy in Alleghany at the
same price is an ultra vires act (“beyond the powers” When a corporation
does an act or enters into a contract beyond the scope of its charter) of the
corporation (i.e. against public policy for the bank to give such an option).
3) Furthermore, all of the directors of both companies that voted for or ratified
the purchase have violated their duty of due care. They have not shown
sufficient diligence in allowing the bank to purchase bonds with an option to
sell at the same price (all of the risk is on the bank for a drop in price; if the
price rises, they get no gain.)
4) The directors are responsible for the losses from holding the bonds up to the
expiration date of the option.
Conclusion: This case indicates that the standard of care may vary according
to the kind of business involved and the precise circumstance in which the
directors acted. Good faith makes the difference..
BUSINESS JUDGMENT RULE: (This protects directors from negligence). As
long as a director acts with reasonable skill and prudence the courts will not hold
them liable. The directors are required to act as an ordinary man would at the
time of the act
Business Judgement Rule:
Protects: Directors (and to a lesser degree officers) from decision that don’t
payoff)
Not liable when they act with reasonable skill and prudence.
Court presumes good faith on the part of the director (including that they are
disinterested and they are not beholding to a majority stock holder. They act with
due care: exercise informed, independent juudgement) They are liable if they
don’t exercise due care and make grossly unsound decisions.
Wrigley:
Lttlum/VanGorkhom: Grossly unsound makes you unsound (not heavily accepted
and clauses in the articles limit this via clauses in the Ariticles or insurance)
July 8, 1998 Class Starts Here
Shlensky v. Wrigley (1968)(p. 671)
BUSINESS JUDGMENT RULE
Facts: Shlensky (P), a minority shareholder in the corporation (D) that owns
Wrigley Field and the Chicago Cubs, brought a shareholder’s derivative suit
against the directors of the corporation for their refusal to install lights at Wrigley
Field and schedule night games for the Cubs as other teams in the league had
done (to increase revenues). The directors’ motivation was allegedly the result of
the views of Mr. Wrigley (also a defendant), the majority shareholder, president,
and a director of the corporation, who wanted to preserve the neighborhood
surrounding Wrigley Field and who believed that baseball was a daytime sport.
The lower court dismissed P’s action.
Issue: May a shareholder bring a derivative action where there are no allegations
of fraud, illegality, or conflict of interest?
Rule: No. Affirmed.
1) The court will not disturb the “business judgement” of a majority of the
directors – absent fraud, illegality, or a conflict of interest. There is no
conclusive evidence that the installation of lights and the scheduling of night
games will accrue a net benefit in revenues to D, and there appear to be
other valid reasons for refusing to install lights, e.g. the detrimental effect on
the surrounding neighborhood.
2) Corporations are not obliged to follow the direction taken by other similar
corporations. Directors are elected for their own business capabilities and not
for their ability to follow others.
Key: Note 8 (p. 675) review. Also (p. 683) Notes 9 & 10
Good faith and process is about the directors take care in the process of
making the decision. Not that the decision was bad.
Corporate Opportunity (p. 794) The duty of loyalty of directors and officers to
the corporation prevents them from taking opportunities for themselves that
should belong to the corporation.
1) Use of corporate property: Clearly a director may not use corporate
property or assets to develop his own business or for other personal use.
Looting Theory: In a situation where the purchaser buys only the controlling
stock, the controlling shareholders may be liable to the minority when the
purchaser later “loots” the corporation (if the majority shareholders knew or had
reason to know that the purchaser intended to loot the corporation). Paying a
“premium” is one indication or notice of possibly intended “looting.”
Sale of corporate assets: Where the purchaser buys only the majority stock, the
majority may be liable for any premium received if the corporation has some
particular “corporate asset” that creates this premium, since this asset belongs to
all shareholders equally. But what constitutes a “corporate asset”? Isn’t this
involved in every corporate sale, so that whenever a purchaser offers to buy
control he must give this same offer to minority shareholders?