* Business Associations (Corporation)

* Business Associations (Corporations) *

** Forming a De Jure Corporation (Need People, Paper & Act)
1. People ( = Incorporators): Must have one or more incorporator (human or entity)
2. Paper ( = Articles of Incorporation)
  1. The articles are a contract between the corporation and the shareholders; or the corporation and the state
  2. The skeletal information required: Names & Addresses & Duration & Authorized Shares (i.e., maximum of shares the corporation is authorized to issue) & Statement of Purpose
    1. General statement of purpose: “This corporate shall engage in lawful activity” will be valid in the absence of a specific purpose
    2. Specific statement of purpose: “Purpose to sell shirts”, yet if the company goes beyond this, for instance, selling shoes, then this becomes Ultra Vires (this will be explained later) **
3. Act: Incorporators must sign and deliver the articles to the Secretary of State and pay the fees
  1. After these three steps, the De Jure Corporation is created
    1. If the incorporators failed to form a De Jure Corporation, they will be personally liable for what the business does because it becomes a General Partnership. This is explained in “Business Associations (Agency & Partnership)”) **

2. De Facto Corporation & Corporation by Estoppel

If the De Jure Corporation is not established due to some errors in the process, the people will be liable for it becomes a General Partnership, unless the court will determine the Corporation is either De Facto Corporation or Corporation by Estoppel
1. De Facto Corporation
  1. The business is treated as a corporation for all purposes even though it was not actually created due to the errors in the process:
    1. if the Paper ( = Articles of Incorporation) has been correctly filed (i.e., it is always satisfied to be a De Facto Corporation);
    2. the parties made a good faith, colorable attempt to comply with the corporate formalities (i.e., steps and precautions that the business must take to ensure that the corporation remains legally distinct from its owners, for the owners are generally shielded from liability and can lose only their financial investment in the business if something goes wrong. However, for the business to actually exist as a separate entity – which is key to maintaining the liability protections that are in place – corporate formalities must be maintained. The examples of corporate formalities are maintaining separate financial accounts, keeping accurate records, holding regular meetings, maintaining fiduciary duties, and following company Bylaws) **
      1. Paper (Articles of Incorporation) v. Bylaws
        
        Paper ( = Articles of Incorporation): Before the new corporation exists, it must register with the state where it is doing business to establish the existence of the corporation in that state. The document that is registered is the Paper ( = Articles of Incorporation).
        
        Bylaws: After the company is formed, its Board of Directors ( = BOD = Board) is established. The board decides on bylaws to help direct its operations over the life of the corporation. The bylaws are all about the board and how they must operate to run the company (However, the corporation does not have to adopt bylaws) **
    3. Exercise of corporate privileges (i.e., not knowingly, acting like they had a corporation even though it was not actually created due to the errors in the process);
      1. Note that, however, if a person acts on behalf of a corporation with knowledge that it is an invalid incorporation, that person is subject to individual liability
2. Corporation by Estoppel (Contracts Cases Only)
  1. A person who deals with a business as if it were a corporation, that is not a De Jure Corporation or a De Facto Corporation, may be estopped from denying that it is a corporation and will be personally liable **

3. Pre-Incorporation Contracts

Definition: Promoter (i.e., a person acting on behalf of an unformed corporation) enters into a contract before a corporation is created
The Duty of Promoter
1. Promoters owe a fiduciary duty to the corporation such as providing a full disclosure of all material facts within good faith
  1. However, regardless of whether a promoter made a full disclosure, if the victim can show he or she was damaged by the fraudulent misrepresentation or failure to disclose all material facts by the promoter, the promoter will be personally liable **
Liability of Promoter
1. Unless the contract clearly provides otherwise, the promoter is jointly and severally liable on pre-incorporation contracts along with the corporation unless there is Novation
  1. Novation is an agreement of the promoter, the corporation, and the other contracting party that the corporation will replace the promoter under the contract and release the promoter from liability
  2. Agreement between a promoter and a third party expressly relieves promoter of liability as well **
Liability of Corporation: Generally, the corporation is not liable on pre-incorporation contracts, unless it adopts or ratifies the contract the promoter has entered into. Adoption and Ratification can be made in both:
1. Express: Board takes an action by adopting the contract
  1. Example) Board Resolution
2. Implied: The corporation accepts the benefit under the contract promoter entered into

4. Directors ( = Board of Directors) of Corporation & Issuance of Stock

Statutory Requirements for Directors (Here, you don't need to memorize but just understand the content)
1. Directors - There must be one or more adult as a Director in a corporation
2. Election – The shareholders elect the directors at an annual meeting
3. Removal – The shareholders can remove directors before terms expire with or without cause by majority of shareholders entitled to vote
4. Replacement – Replacing the director is done by the shareholders, or by the Board of Directors ( = BOD = Board) **
5. Valid Board Action (Action) – BOD can take action only by at a valid meeting, and if there is no valid meeting taken place unanimous written consent is necessary
6. Quorum
  1. Definition: The minimum number of members of a group or committee required to be in attendance in order for that group to be able to take official action as to an issue
  2. If there is no quorum, any action taken is void
  3. There must be majority of all directors to form quorum
  4. There must be majority of the directors voting to pass resolution
    1. Example) if there are 8 directors, at least 4 directors must attend the meeting to constitute a quorum. If 4 directors attend, at least 2 must vote for a resolution in order for the resolution to pass
  5. If the directors leave in the middle of the meeting, quorum may be lost
7. Concurrence - Each director is presumed to have concurred in a valid board action unless his dissent or abstention is recorded in writing **
Issuance of Stock (Here, you don't need to memorize but just understand the content)
1. Definition: Issuing a stock means when a corporation sells its own stock
  1. Preemptive Rights – Right of an existing shareholder to maintain his or her percentage of ownership by buying stock whenever there is a new issuance of stock for cash
    1. Note – No preemptive rights unless expressly granted in the Articles of Incorporation ( = Paper)
  2. Consideration – What corporation receives when issuing the stock to the shareholders
    1. Par value – Minimum issuance price. The corporation must never receive less than par value
      1. Acquiring Property with par value stock – Any valid consideration may be received if the Board values the consideration in good faith to be worth at least par value
    2. No Par Value – No minimum issuance price
      1. The corporation may sell the stock for any valid consideration deemed adequate by the Board
    3. Treasury Stock – Previously issued stock that has been reacquired by the corporation
      1. The corporation may sell the stock for any valid consideration deemed adequate by the Board
    4. Consequences of Issuing Par Stock for Less than Par Value
      1. Directors are personally liable
      2. Shareholders are liable for paying full consideration for his or her shares **

5. Liability of the Directors

Duty to Manage
1. Directors have a duty to manage the corporation
  1. Shareholders have no power to manage the corporation yet have the power to elect the directors
Fiduciary Duty
1. Duty of Care
  1. Standard: Directors owe the corporation a Duty of Care
  2. Directors must act in Good Faith& do what a Reasonable Person would do
  3. Burden of Proof when the Directors violate their Duty of Care to the Corporation:
    1. When the Directors violate their Duty of Care to the Corporation, the burden of proof is on the Plaintiff (i.e., here the Plaintiffs are generally the shareholders or clients)
      1. Plaintiff needs to prove Directors are at fault when problem initiates
  4. Two types of violation by the Director as to Duty of Care
    1. Nonfeasance (Director did nothing much but damage resulted. In this case the director is regarded to have committed Negligence)
      1. Apply the elements of Negligence (a) duty, (b) breach, (c) causation (i.e., cause in fact or proximate cause), and (d) damage (This will be explained in details in “Torts”)
      2. Apply “a Reasonable Person Standard” (This will be explained in details in “Torts” as well) **
    2. Misfeasance (The director acted in a way that hurts the corporation. Therefore, the causation in these cases are clear thus the director will be liable for his or her act)
      1. However, the Director still may not be liable for his or her action under the rule below
        
        Exception to Misfeasance
        
        The Business Judgment Rule (BJR)
        
        Directors are protected from misfeasance liability via the BJR
        
        In order for the Directors to be protected via the BJR, the directors must prove that in making a business decision they:
        
        acted on an informed basis;
        
        acted in good faith;
        
        without conflicts of interest (i.e., involves a person who has two deals that might compete with each other benefitting one party but not the other); and
        
        had a rational basis that the action was in the best interest of the corporation
        
        Directors will be liable for the violation of Duty of Care under Misfeasance, if any of the four above are not satisfied
        
        However, directors will not be liable for innocent mistakes of business judgment **
2. Duty of Loyalty
  1. Standard: Directors owe the corporation a Duty of Loyalty
  2. Directors must act in good faith & with a reasonable belief that what he or she does is in the best interest of the corporation
  3. Burden of Proof when Directors violate their Duty of Care to the Corporation
    1. When Directors violate their Duty of Loyalty to the Corporation, the burden of proof is on the Defendant (i.e., here the Defendants are generally Directors)
    2. Defendants needs to prove Directors himself or herself are not at fault
  4. Types of Violation of Duty of Loyalty by Director against the Corporation
    1. Self-Dealing
      1. Interested Director Transaction **
        
        This is any transaction between the corporation and one of its directors who has personal financial interest, receiving unfair benefit to himself or herself, or a close relative of the director, or another business of the director to the detriment of the corporation or his or her shareholders
        
        Interested Director Transaction will generally be rescinded, or the directors will be liable in damages. However, the directors will not be liable under the "Interested Director Transaction" if the director shows either:
        
        transaction was fair to the corporation when entered into; or
        
        the interest of the director and the relevant facts were disclosed or informed to the corporation; and
        
        the transaction was approved either by a majority of disinterested directors or a majority of disinterested shareholders in a meeting; or if there was no meeting, approved by unanimous written consent of disinterested directors
        
        Note that in order for the director not to be liable when he or she went under the "Interested Director Transaction", the director must prove either 1 or 2 above, and 3 must always be proved
    2. Competing Ventures
      1. Directors cannot compete with the corporation
      2. Remedy: If the directors actually compete with the corporation and incur damages, the corporation gets the profit by the directors pursuant to a constructive trust (i.e., a constructive trust is imposed by a court in order to avoid unjust enrichment of the person who is holding the property on behalf of another person. By establishing this legal relationship, the person who is wrongfully holding the property of another must transfer its ownership to the intended party) **
    3. Usurping Corporation Opportunities
      1. Directors cannot usurp (i.e., take illegally or by force) a corporate opportunity
      2. In order for the directors to take corporate opportunity legally, the directors must:
        
        give notice to the corporation; and
        
        allow the corporation a chance to pursue the opportunity, and later if the corporation rejects the opportunity, then the directors may pursue the opportunity
        
        Types of opportunities the directors must yield to corporation first are, (i) similar line of business to the corporation, (ii) similar business that the corporation has interest or expectancy, or (iii) business the director has found during his or her corporation working time or with corporation resources
      3. Remedy for the Corporation
        
        The directors must sell the opportunity to the corporation at cost
        
        If another corporation already purchased the opportunity, the corporation gets the profit pursuant to a constructive trust (i.e., a court order, where the person who would otherwise be unjustly enriched, to transfer the property to the party who is intended to receive) **
      4. Defense by the Directors against the Corporation
        
        Corporation was not interested in the opportunity
        
        Yet the financial inability of the corporation to pay for the opportunity cannot be a defense by the directors
    4. Improper Distributions
      1. Directors are jointly and severally liable for improper distributions of funds to the shareholders, unless the distribution was made in good faith
      2. Shareholders are personally liable if they knew the distribution was improper when they received it
    5. Proper loans
      1. Loans to the directors are proper if it is reasonably expected to benefit the corporation
        
        Example) Loans to a director who is entering a business school to learn more about the knowledge, skills concerning the corporation **
    6. Ultra Vires Act
      1. Definition: An act performed by corporate directors or officers that is beyond the scope of his or her legal authority
        
        Example) The president of a corporation may perform an ultra vires act by selling a large portion of the corporate assets without shareholder approval, if the corporate bylaws require that such approval be obtained beforehand
      2. Remedy
        
        The shareholder can seek injunction (i.e., a court order requiring a person to do or cease doing a specific action) to stop the ultra vires act
        
        The corporation may sue its own directors and officers for losses caused by the ultra vires act
        
        The state seeking to dissolve the corporation for engaging in ultra vires act
        
        Note the difference between shareholders, directors, and officers (shareholders are the owners of the corporation and elect the directors; directors guide and are involved in the fundamental decisions of the corporation on behalf of the shareholders; and officers are selected by the directors and run the day-to-day operations of the corporation. However, note that these do not need to be separate individuals. Any person can fill all positions. At times, in small businesses, one person can be the shareholder, the director, and the officer at the same time)
      3. Defense
        
        Directors and officers reasonably relied on good faith information when performing the act **
3. Indemnification & Reimbursement
  1. Indemnification
    1. Directors or officers that have incurred costs, attorney fees, fines, a judgment or settlement in the course of corporate business, may seek indemnity from the corporation
      1. The corporation may never indemnify a director who is held liable to their own corporation in the lawsuit
      2. The corporation must always indemnify if a director or officer wins a lawsuit against any party, including their corporation
      3. The corporation may indemnify directors or officers if:
        
        Liability is incurred to third-parties (judgment or settlement), and
        
        Director or officer shows that she acted in good faith and that her or she believed her conduct was in the best interest of the corporation **
      4. Who may determine whether to grant permissive indemnity
        
        The majority vote of independent directors
        
        The majority vote of committee of at least two independent directors
        
        The majority vote of shares held by independent shareholders
        
        Special legal counsel opinion can recommend
  2. Reimbursement
    1. Notwithstanding these rules, the court where the director or officer was sued can call for reimbursement if it is justified in view of all circumstances **

6. Corporate Shareholders

Definition: Corporate Shareholders, referred to as a stockholder, is a person, company, or institution that owns at least one share of a stock of the company, which is known as equity. The corporate shareholders are essentially owners in a company
Administration of the Corporation by the Corporate Shareholders
1. Generally, shareholders do not administer the corporation. Directors ( = Board of Directors) administer the corporation
Rights of Shareholders
1. Exceptionally, shareholders can administer the corporation directly in “Closed Corporation”
  1. Definition of Closed Corporation: The shares of the corporation are generally held by a small number of people and are not available for sale or purchase in the public markets (i.e., yet the shares of the corporation could be available for sale or purchase in 'a private transaction' if it is allowed). In this case, the shareholders can directly administer the closed corporation
    1. Duty of Loyalty & Duty of Care
      1. And when the shareholders get to administer the closed corporation, he or she will be subject to the duty of loyalty & the duty of care toward the corporations, as the directors do **
    2. Fiduciary Duty
      1. In a closed corporation, as in the general partnership (i.e., an agreement between partners to establish and run a business together. This will be explained in “Agency & Partnership”):
        
        the controlling shareholders (i.e., a shareholder who owns more than half of the shares or majority of the outstanding shares in a company) owe a fiduciary duty to the minority shareholders. This means that controlling shareholders must deal with minority shareholders with honesty, good faith, loyalty, and fairness
        
        The controlling shareholders must not repress the minority shareholders by harming the economic interests or unfairly prejudicing them (i.e., refuse to declare dividends (i.e., amount paid regularly by a corporation to its shareholders out of its profits))
        
        If the controlling shareholders repress the minority shareholders, the minority shareholders can sue the controlling shareholders
2. Rights of Shareholders in Access of Documents
  1. Rule
    1. Generally, any shareholder can demand access to documents needed
  2. Procedure
    1. The shareholders must make a written demand stating the documents desired, and a proper purpose that is reasonably related to the role as shareholder, such as investigating corporate mismanagement
    2. If the corporation fails to allow proper inspection, the shareholder can seek a court order
    3. If the shareholder wins, she can recover costs and attorney fees incurred in making the motion
    4. Note that directors do not need to through this procedure for they have unfettered access **
Liability of Shareholders
1. Generally, shareholders have limited liability (i.e., not liable) for the acts and duties of corporation nor the third party that is related to the corporation
  1. The liability of the shareholder is limited to the nominal value of its own shares (i.e., any unpaid amount on the shares held by the shareholder)
2. However, a shareholder might be personally liable for what the corporation did if the court Pierces the Corporate Veil to avoid fraudulent or unfair acts by the shareholders, which normally happens in Closed Corporation
  1. In order to PCV (i.e., to hold shareholders personally liable):
    1. there must be a proof that it would be unfair if the court does not PCV; **
      1. Alter Ego Doctrine
        
        The doctrine is to invoke a personal liability on corporate shareholders, especially when it finds a lack of distinction between the shareholders and the corporation. That is, the shareholders have treated the corporation as their alter
        
        And because of this alter ego situation, it would be unjustified for the shareholders to escape personal liability
        
        Examples leading toward the Doctrine which will make the court PCV (i.e., which will make the shareholders personally liable):
        
        commingle personal shareholder fund and corporate funds and other assets
        
        issue stock without corporate authority
        
        misrepresent ownership, assets, and financial interests
        
        avoid creditors by transferring assets to shareholders **
    2. the corporate formalities (i.e., hold regular meetings, maintain fiduciary duties, maintain separate financial accounts, keep accurate records, follow company bylaws) were ignored by the shareholders and thus, injustice resulted;
    3. the corporation is being used to perpetrate a fraud by the shareholders; or
    4. the corporation was inadequately capitalized (i.e., funded) at the time of its formation
      1. Undercapitalization
        
        Undercapitalization means that the corporation does not have enough money to be carried on and to pay its debts and liabilities because of its lack of investment. If your business is undercapitalized, a court could decide to PCV and hold the shareholders personally liable for the debt of the corporation because the court will regard the undercapitalized situation as shareholders purposefully keeping the money out of the business in order to defraud or avoid any liability **
Corporate Shareholder Derivative Suit
1. Definition
  1. In a derivative suit, a shareholder is bringing a lawsuit to enforce the claim of the corporation on behalf of the corporation because the corporation incurred damages
  2. This is a case where the corporation is not pursuing its own claim, when the corporation could have, but did not, thus, a shareholder steps in to prosecute a person or entity who harmed the corporation for the sake of the corporation
    1. Example) A shareholder is suing the Board of Director for usurping corporate opportunities because it harmed the corporation and the corporation is not bringing the lawsuit for itself
2. Requirements
  1. Requirements for bringing a derivative suit:
    1. It is important for the shareholders to make a written demand on the corporation that the corporation bring the lawsuit first
      1. Note that, if the shareholders can show the written demand is futile, then there is no need to a write a written demand to the corporation
    2. Yet, there could be a case where the demand made by the shareholders was rejected by the corporation, or at least 90 days passed since the demand by the shareholders was made and no response by the corporation
      1. In this case, the shareholders may sue on behalf of the corporation (i.e., however, in order for the shareholders to bring a lawsuit on behalf of the corporation, shareholders must own at least one share of stock when the claim arose and throughout every stage of the litigation)
        
        Note that, the shareholders bringing the lawsuit must have owned the stock at the time the claim arose, or have gotten it by operation of law (e.g. inheritance or divorce decree) from a person who did own it at the time the claim arose
    3. And when the shareholders does bring the lawsuit on behalf of the corporation, the shareholders must adequately represent to the best interest of the corporation
      1. Note that, the corporation can move to dismiss the lawsuit shareholders brought on the basis that the independent investigation showed the lawsuit was not the best interest of the corporation
3. Results
  1. If the shareholders wins the derivative suit, the corporation gets the money from the judgment
  2. If the shareholders lose the derivative suit, the shareholders cannot recover the costs and attorney fees, and the shareholders will also be liable for the legal costs and attorney fees of the D if the shareholders sued without a reasonable cause **

7. Fundamental Corporate Change

Definition: Transfer of corporate assets; consolidation; merger; or dissolution
1. Difference between Consolidation & Merger
  1. Consolidation: when multiple companies join to form a new entity (e.g., company X & H consolidate together, and creates a new company L)
  2. Merger: when one or more company merges into an existing entity (e.g., among business X & H & L, X & H merges into L, making a bigger company through L) **
2. Dissolution
  1. Definition: Dissolution is the end of the legal existence of a corporation.Dissolution generally occurs when the purpose of the business is completed or ceases to be economically viable.It usually occurs after liquidation(i.e., the process of paying debts and distributing the remained assets)
  2. Types of Dissolution
    1. Voluntary Dissolution
      1. Definition
        
        An action taken by corporate shareholders or initial directors to dissolve a corporation
      2. Dissolution Procedure:
        
        first, Board of directors(i.e., Director) take action by filing notice of intent to dissolve with the Secretary of State
        
        next, the corporate shareholders approve
        
        next, the corporation stays in existence to wind up(i.e., the process of dissolving a company, which purpose is to sell off stock, pay off creditors, and distribute any remaining assets to general partners or shareholders)
        
        lastly, notify creditors in order for them to make claims against the corporation **
    2. Involuntary Dissolution
      1. Definition
        
        Involuntary Dissolution is generally done by court order
      2. Rule
        
        A corporation may face the involuntary dissolution in the event of a serious disagreement with the corporate shareholders as to whether or not it should be dissolved. It could also be the result of the bankruptcy, failure to file important reports with the state, failure to pay taxes, or other irreparable conditions
        
        A corporate shareholder can petition for involuntary dissolution because:
        
        the directors of the company have engaged in illegal or fraudulent activities;
        
        assets of the corporation have been spent unwisely or otherwise wasted;
        
        it is reasonably necessary for the protection of the rights or interests of the complaining shareholder; or
        
        there is a deadlock among the directors of the corporation regarding a crucial decision, and they are unable to resolve it **
        
        A creditor can petition for involuntary dissolution because:
        
        the corporation cannot fulfill its financial duty due to lack of financial resources,
        
        the creditor has an unsatisfied judgment given by the court; or
        
        the corporation previously has admitted its financial duty toward the creditor in writing **

8. Federal Securities Law

Securities Exchange Act of 1934: Section 10(b)
1. Definition of Security
  1. A simple definition of a security is any proof of ownership or debt that has been assigned a value and may be offered for sell. Examples are stocks, bonds and options (i.e., options are derivatives of financial securities. Their value depends on the price of other asset. That is, an option is a derivative because its price is intrinsically linked to the price of another asset. There are options which gives the holder the right to buy a stock, and options which gives the holder the right to sell a stock)
2. Definition of Securities Exchange Act of 1934
  1. This Act is a federal law that regulates the secondary trading of securities such as stocks and bonds. The secondary market is the market for securities after they have been issued. The primary market is the market for newly-issued securities **
3. Application of the Act
  1. This Act applies when there exists ‘deception’ (i.e., material misrepresentation or failure to disclose a material fact in breach of a fiduciary duty)
    1. Note that being silent is not a material misrepresentation. Namely, absent a duty to speak is not material misrepresentation. Yet, it is required to speak when periodic disclosure of a fact is required **
  2. The Act applies when there exists Insider Trading
    1. Definition of Insider Trading: To buy or sell a security, in breach of a fiduciary duty or other relationship of trust and honesty between the parties, on the basis of non-public important information as to security
    2. Factors of Insider Trading
      1. Deception
        
        Deception is trading on or tipping inside information
        
        There is a tipper (i.e., this is a term that is used generally in the field of federal securities law. Tipper is a person who tips inside information for personal benefit to another who trades on it)
        
        There is a tippee (i.e., this is a term that is used generally in the field of federal securities law. Tippee is a person who receives inside information and trades on it with knowledge that the information was disclosed in breach of the fiduciary duty of the tipper)
      2. Deception is made in connection with the actual purchase or sale of securities **
4. Private Action by the Investors against the Insiders under the Act
  1. Rule
    1. The investors must prove:
      1. they actually relied on fraud, or invested at a price infected by fraud, and
      2. the fraud incurred by the insiders actually caused the economic loss of the investors
Security Exchange Act of 1934: Short-Swing Profit Rule
1. Definition of Short-Swing Profit Rule
  1. Under the Securities Exchange Act of 1934, this rule is an additional regulation that requires corporation insiders to return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period
  2. Purpose of the Rule
    1. This rule was implemented to prevent corporation insiders (e.g., directors, shareholders, officers of a corporation that is listed on national exchange), who have greater access to important corporation information, from taking advantage of the information for the purpose of making short-term profits
      1. Note that ‘deception’ or ‘inside trading’ is not required to be held liable under this rule
  3. Liability in case of a Violation of the Rule
    1. The corporation will be able to recover all profits from the person who violated the Act
  4. Example)
    1. If a director buys shares in November and sells these shares in December, and the director made a profit, because the buy-and-sell of the shares were done within a six-month period, the director would have to return the profit to the corporation voluntarily **

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