Corporations - Summary Introduction to Law PDF

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Corporations Promoter’s liability The “promoter” is the person who creates a corporation Promoters often enter into contracts for the corporation before the corporation is formed A promoter is personally liable on contracts signed before the corporation formed A corporation is not liable on contracts signed before it is formed unless it adopts the contract after incorporation To adopts a contract the corporation’s board of directors must formally vote to do so A promoter remains liable for pre-incorporation contracts unless the other party to the contract, the corporation, and the promoter enter into a novation A novation is a three-party contract between the two original parties to the contract (in this case, the promoter and the third party), and the new party to the contract (the corporation), in which the third party expressly agrees to release the promoter from all liability for the contract, and to look only to the corporation to perform contractual duties If the facts make it clear that the parties did not intend the promoter to be liable, then the promoter is released from liability once the corporation adopts the contract Incorporation Process The incorporation process is governed by state law To form a corporation, one must file Articles of Organization with a state’s Secretary of State A/k/a Charter, Articles of Incorporation, Certificate of Incorporation The Articles of Organization must contain the information required by the state’s incorporation statute and may contain certain optional information What factors influence the decision on where to incorporate? Where will the corporation do most of its business? What expenses and fees will the corporation incur to qualify to do business in states other than its domicile? Which state’s corporation laws would be most advantageous to this corporation?

Delaware is a popular choice becauseIts laws are pro-management, Its Chancery Court deals only with cases arising under the state's business entity laws, It has a well-established case law concerning corporations, and Venture capital and other securities firms are well-versed in Delaware corporate law Domestic versus foreign corporation A corporation is a “domestic corporation” in the state in which it is incorporated The corporation is “domiciled” in its state of incorporation A corporation is a “foreign corporation” in every other state A corporation must file the forms required to qualify to do business as a foreign corporation in every state outside of its domicile where it has an ongoing presence Qualifying to do business is ministerial, not discretionary In other words, if the corporation is in good legal standing in its domicile and submits the forms and fees required to do business in the foreign state, the state must qualify it to do business there Charter’s Required Provisions Corporate name The corporation’s name must include reference to its corporate status "Inc.,” "Incorporated", "Corporation,” "Ltd.,” “company” Why? A corporation’s name must be different from or not deceptively similar to any other corporate, limited partnership, or limited liability company name in the state of incorporation Address and registered agent The charter must provide the name and address of the corporation’s registered agent The registered agent isThe official address where the corporation may be contacted, and The agent on whom a party suing corporation can serve a complaint Incorporator The incorporator signs the charter and delivers it to the Secretary of State Incorporator is not required to be an owner or officer of the corporation E.g., Incorporator is often the lawyer who drafts the charter

Corporate purpose Most corporate charters contain a broad statement of purpose e.g., “The nature of the business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware” Stock Par Value This no longer bears any relation to the market value of a stock Most stock now has either no par value or a nominal par value, e.g. $.01 Number of authorized shares The charter must authorize stock before a corporation can sell it A corporation can authorize as many shares of stock as the incorporators choose The amount of the filing fee a corporation pays upon formation depends on how many shares of stock it authorizes Authorized and unissued stock Stock the corporation has authorized but not yet sold Authorized and issued stock A/k/a “outstanding stock” Stock the corporation has authorized and sold Treasury stock Stock the corporation has authorized, sold, and repurchased Classes and Series Class A category of a corporation’s stock Series A sub-category of a corporation’s class of stock All stock in a series must have the same rights as other stock in that series A corporation can allocate various stock rights between and among classes and series of stock Voting right Whether a share is entitled to vote

Dividend rights Whether, and in what amount, a share is entitled to receive a dividend

Liquidation rights How a share will participate in distribution of corporate assets on dissolution Preemptive rights The right to purchase new shares to maintain a certain percentage ownership in the corporation Conversion rights The right to convert a share into shares of a different class Redemption rights The right to require the corporation to repurchase a share Preferred stock Has a preference on dividends and liquidation Holders of preferred stock receive unpaid dividends and their share of liquidation proceeds before holders of common stock receive anything Cumulative preferred stock If the corporation does not pay dividends one year then holders of cumulative preferred stock are entitled to receive all unpaid dividends in the next year in which the corporation pays dividends before common shareholders receive any dividends In other words, unpaid dividends accumulate Non-cumulative preferred stock If the corporation does not pay a dividend one year then holders of non-cumulative preferred stock lose the right to receive payment of it In other words, unpaid dividends do not accumulate Common stock Is last in line for corporate payouts, including dividends and liquidation payments Holders of common stock receive what is left, if anything, after debt holders and preferred shareholders receive what they are owed Participating preferred stock Upon liquidation holders of participating preferred stock are paid first, receiving what they paid for the stock plus accrued dividends They then are treated as if they had converted their shares to common stock, and share proceeds with the other common shareholders After Incorporation

Directors and officers Under Model Act a corporation must have at least one director unlessAll of the shareholders agree in writing to eliminate the board, or The corporation has 50 or fewer shareholders Minute book Records of corporate votes are kept in the corporation’s minute book The minute book must be kept in good order and up-to-date to prove that the corporation’s officers and directors have been duly authorized to act for the corporation Bylaws A corporation’s bylaws establish details suchThe date for annual meetings, The definition of a quorum, Name and function of corporate offices Bylaws are easier to amend than are articles of incorporation, and are thus better suited to contain such housekeeping details Corporate debt Bonds Long-term debt secured by specific assets of the corporation Debentures Long-term unsecured debt Notes Short-term debt May be either secured or unsecured Death of the Corporation Piercing the corporate veil The doctrine of piercing the corporate veil allows a corporate creditor to ask a court to disregard corporate limited liability and hold the corporation’s shareholders personally liable for corporate obligations In a close case a court may be more likely to pierce the veil for an involuntary creditor than for a voluntary creditor

Why? NB: This does not alter the general rule that piercing the corporate veil is an extraordinary remedy that courts wield only in the most compelling cases A court may pierce the corporate veil if: A corporation fails to observe corporate formalities, e.g., it fails to hold required meetings, keep an up-to-date minute book, and file reports required by state law A corporation’s owners commingle the corporation’s assets with their personal assets, e.g., shareholders use corporate assets to pay personal debts, or maintain corporate and personal funds in the same bank account A corporation is inadequately capitalized, or The corporation's capitalization must be grossly inadequate in light of its anticipated capital needs NB: this does not mean that a court is likely to pierce the corporate veil of every corporation that fails Doing so would remove the incentives to incorporate A corporation’s owners defraud creditors through the corporation AZTE, Inc. v Auto Collection, Inc., 36 Misc. 3d 1238(a) (Supreme Court of NY 2012) Facts: Auto Collection, Inc. sold user luxury cars to buyers in Eastern Europe. Steven Lever owned 90% of Auto, and his wife and son Joshua each owned 5%. Steven controlled Auto’s finances and maintained Auto’s corporate records. Auto’s bank account listed Steven’s personal address, not Auto’s corporate address. Steven capitalized Auto with a few thousand dollars, but did not keep track of further capital contributions. He claimed to loan Auto $900k, but there was no loan documentation. He deposited and withdrew money from Auto’s bank account at his sole discretion. Joshua became Auto’s employee, receiving $474k in compensation in one year although Auto did not deliver any cars customers had paid for. Plaintiffs sued Auto, Steven, and Joshua for $500k Issue: Should the court pierce Auto’s corporate veil? Are Steven and Joshua personally liable for Auto’s debts? Yes as to Steven, no as to Joshua. Even where outright fraud is not proven, “where a corporation is so dominated by its principal that its separate identity has been ignored, such that the principal’s interests take precedent over and control the business purpose of the corporation, and the corporation then becomes the alter ego of the principal, the corporate veil may be pierced to avoid justice.” Steven was aware of and controlled every corporate transaction, treating Auto’s assets as if they were his own. He ignored corporate formalities (using his personal address on the bank account and failing to document the loan). However, there is insufficient evidence that Joshua, a 5% owner of Auto, treated the corporation as his alter ego, even though he received substantial compensation.

Termination Terminating a corporation involves three steps Vote Directors recommend to shareholders that the corporation be dissolved The shareholders vote to approve dissolution Filing The corporation files Articles of Dissolution with the secretary of state Winding Up/Corporate Liquidation The corporation pays its liabilities and distributes any remaining assets to shareholders The process of converting all corporate assets to cash is called “liquidation” When this process is completed the corporation ceases to exist Management Duties Corporate Managers In this course, unless the context clearly shows otherwise, the term “corporate manager” refers to both corporate officers and corporate directors Scope of directors’ duties “A corporation's board of directors is responsible for and obligated to manage the business and affairs of the corporation” (from the Delaware corporation statute) "All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors . . ." (from the Model Business Corporation Act) Managers and shareholders Generally, directors are construed to owe a fiduciary duty to act in the best interests of the corporation’s shareholders Stated simply, managers must maximize shareholder value The course of action that will best maintain shareholder value is not always readily apparent How do you define shareholder value? Is it short-term value? Long-term value? The Business Judgment Rule The business judgment rule is a presumption that, in making a business decision, the directors of a corporation acted-

On an informed basis, In good faith, and In the honest belief that the action taken was in the best interests of the company What is the significance of the business judgment rule being a presumption? The '" . . . judgment of directors of corporation in making business decision will be respected by the courts absent an abuse of discretion n. . .'"1 Purposes of the business judgment rule Helps reduce the risk of liability for corporate decisions that are likely to dissatisfy one or more stakeholders Minimizes second-guessing of corporate decisions by judges Encourages directors to serve by minimizing the number of successful attacks on corporate decisions Applicability To be protected by the business judgment rule managers must act in good faith If a manager does not act in good faith then the business judgment rule does not apply and his decision will lose the benefit of the presumption E.g., if a manager engages in self-dealing then the business judgment rule does not apply If the business judgment rule does not apply then the court will scrutinize the decision to determine whether it is valid Validity determined by whether the decision was entirely fair to the corporation Duty of loyalty The duty of loyalty prohibits managers from making a decision that benefits them at the expense of the corporation Self-Dealing Occurs when a manager makes decisions that benefit himself or other companies with which he has a relationship If a manager engages in self-dealing the business judgment rule no longer applies A self-dealing transaction is still valid ifThe disinterested directors approve the transaction, The disinterested shareholders approve the transaction, or The transaction was entirely fair to the corporation 1 Aronson v. Lewis, Del. Supr., 473 A.2d. 805, 805 (1984)

Corporate Opportunity Doctrine Managers violate their duty of loyalty if they compete against the corporation without its consent Factors that determine whether the Corporate Opportunity Doctrine applies Is the opportunity within the corporation's line of business? Does the corporation have an expectancy in the opportunity? Have the corporation's resources been used to pursue a similar prior opportunity? Did the opportunity come to the corporate executive in his individual or his corporate capacity? Will the executive's acceptance of the opportunity injure the corporation? Anderson v. Bellino, 2003 Neb. LEXIS 49 (NE 2003) Facts: Bellino and Anderson formed and were equal owners in LaVista Lottery, Inc. to operate a restaurant, lounge, and keno game in LaVista, Nev. Over nine years Lottery grossed > $100 million, and Bellino and Anderson each received >$4 million in salary and dividends. Bellino spent more time on the business than Anderson, but never complained about Anderson’s role, and Anderson did everything Bellino asked him to do. However, Bellino resented Anderson’s work ethic, and convinced the city council to put the keno contract up for competitive bid. He incorporated LaVista Keno to bid on the contract, and notified Anderson that because he was working too hard on the business for the money he made, he would resign from Lottery and bid on the contract himself. Anderson offered to do more to help, but Bellino refused. When he bid on the keno contract he was still an officer of and 50% shareholder in Lottery. Anderson also bid on the contract, but Bellino won the bid through Keno. Anderson and Lottery sued Bellino and Keno for breach of the corporate opportunity doctrine. The trial court ruled for Anderson and Lottery and awarded damages to them. Bellino appealed. Issue: Did Bellino take a corporate opportunity? Is he liable to Lottery? Yes. The corporate opportunity was not the right to bid on the Keno contract, but the award of the contract itself. Bellino’s successful bid for the LaVista keno contract deprived Lottery of its only source of business. Duty of care Manager must act with the care that an ordinarily prudent person would take in a similar situation, and In a manner he reasonably believes to be in the best interests of the corporation “Rational Business Purpose” Test If a business decision has no rational business purpose thenManagers are liable to corporate shareholders for the economic harm caused by the decision, and

The decision can be rescinded Is it difficult for a corporate decision to pass the rational business purpose test? The focus on a director’s duty of care is procedural To satisfy his duty of care, a director must diligently gather and evaluate information concerning a corporate decision, and make a reasonable decision based on that information The business judgment rule will protect a manager from liability for a bad decision if in taking the decision the manager satisfied his duty of loyalty and duty of care...