Corporations

Curing Conflicts

A conflict of interest can be cured and the transaction will not be enjoined or give rise to an award of damages if 1) the transaction is approved by a majority of disinterested directors after all material facts have been disclosed to the board; 2) the transaction is approved by a majority of disinterested shareholders' votes after all material facts have been disclosed to the shareholders; or 3) the transaction is fair to the corporation. In determining whether a transaction is fair, courts will often consider the adequacy of consideration, corporate need, corporate finances, and available alternatives. A fact is material if an ordinarily prudent person would consider it important in deciding whether to proceed with the transaction.

Procedure for Fundamental Corporate Change

A corporation undertaking a fundamental corporate change must adhere to the following procedure: 1) a majority of board of directors must adopt a resolution recommending the change; 2) notice of the proposed change must be sent to all shareholders whether or not they are entitled to vote 10-60 days in advance of the meeting describing the change and informing them that a vote will be taken at a shareholder's meeting; 3) approval by a majority of all votes entitled to be cast; and 4) the change must be formalized in the corporation's articles of incorporation filed with the state. Note that the majority of directors and shareholders authorizing the fundamental corporate change must be disinterested.

Business Judgment Rule

A court will not second-guess a business decision if it 1) was Informed, 2) had a Rational basis; 3) was made without Conflicts of interest; and 4) was made in Good faith.

De Facto Corporation

A de facto corporation has all the rights and powers of a de jure corporation but remains subject to direct attack in a quo warranto proceeding by the state. For a de facto corporation to exist there must have been 1) a statute under which the entity could have validly incorporated; 2) colorable compliance with the statute and a good faith attempt to comply; and 3) the conduct of business in the corporate name and the exercise of corporate privileges. The de facto corporation doctrine can only be raised as a defense to personal liability by someone who was unaware there was no valid incorporation.

De Jure Corporation

A de jure corporation is a corporation formed in compliance with all statutory requirements. To create an incorporation, the incorporators must file articles of incorporation with the state. Corporate existence begins upon this filing with the state and is conclusive proof of corporate existence. After the articles are filed, the corporation will have an organizational meeting to elect directors, appoint officers, and adopt bylaws.

Interested Transactions

A director has a conflicting interest in a transaction if the director knows that she or a person she is related to is 1) a party to the transaction; 2) has a beneficial interest in the transaction such that the interest reasonably would be expected to influence the director's judgment; 3) is a director, partner, agent, or employee of another entity with whom the corporation is transacting and the transaction is of such importance to the corporation that it would in the normal course of business be brought before the board.

Duty of Loyalty

A director owes the corporation a duty of loyalty to avoid conflicts of interest.

Corporate Opportunity Doctrine

A director's duty of loyalty prohibits her from diverting a business opportunity from the corporation to themselves without first giving the corporation an opportunity to act. A corporate opportunity is 1) an opportunity the corporation has an interest or expectancy in; 2) an opportunity in the line of the corporation's business; or 3) an opportunity the director discovered on company time or company resources. The director may not take the opportunity until she 1) tells the board about it and (2) waits for the board to reject the opportunity.

10b-5 Tippee

A tippee is liable under 10b-5 if the tipper breached a duty by disclosing the information and the tippee knew that the tipper was breaching the duty, and the tippee traded on that information.

Promoters/Liability

Before a corporation is formed, promoters procure capital commitments and other assets that will be used by the corporation after its formation. A promoter's fiduciary duty to the corporation is one of fair disclosure and good faith. A promoter is personally liable to third parties if it enters into an agreement on behalf of an unformed corporation. The promoter remains liable even after the corporation is formed, even if the corporation adopts the contract. The promoter will only be released from liability if there has been a novation or the contract expressly indicates that the promoter is not to be bound, in which case the agreement is construed as a revocable offer to the proposed corporation. The corporation becomes liable on the contract only after adopting the contract. Adoption may be explicit (i.e., by resolution of the board) or implicit (by accepting the benefits of the contract).

Corporation (Definition)

Corporations are legal entities separate and apart from their shareholders.

Duty of Care

Directors must manage and discharge their duties in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and in the best interest of the corporation. Directors who meet this standard will not be liable for corporate decisions that in hindsight turn out to be poor or erroneous due to the deference afforded them under the business judgment rule.

Fundamental Corporate Change

Fundamental corporate changes include 1) major amendments to the articles of incorporation; 2) a merger; and 3) a sale, lease, exchange, or other disposition of all or substantially all of a corporation's property outside the usual and regular course of business (i.e., more than 75% of the assets).

Ultra Vires Act

If a corporation has a narrow business purpose in its articles, it may not undertake activities unrelated to achieving that stated purpose. Activities beyond the scope of the stated purpose are considered "ultra vires." Although ultra vires acts are generally enforceable, remedies include: 1) a shareholder may sue the corporation to enjoin a proposed ultra vires act; 2) the corporation may sue an officer/director for damages for approving an ultra vires act; 3) the state may bring an action to dissolve a corp. for committing an ultra vires act.

Rule 16(b)

Section 16b provides that any profit realized by any director, officer, or shareholder owning more than 10% of the outstanding shares of the corporation from any purchase and sale of any equity security of his corporation within a period of less than six months must be returned to the corporation. This section applies to publicly held corporations whose shares are traded on a national exchange or that 1) have at least 2000 shareholders and 2) more than $10 million in assets. The purpose of section 16(b) is to prevent unfair use of inside information and internal manipulation of price. This is accomplished by imposing strict liability for covered transactions whether or not there is any material fact that should or could have been disclosed; thus, no proof of use of insider information is required. In order to be considered a 10% owner for purposes of section 16(b), the shareholder must have owned 10% of the corporation's stock immediately before the purchase of the stocks.

Rights of Appraisal - Fundamental Corporate Change

Shareholders who are dissatisfied by the terms of a fundamental corporate change have dissenter's rights of appraisal, which allow the dissenter to demand that the corporation buy back its shares at their fair value as determined by an appraiser if the parties cannot agree. The shareholder must 1) give notice of intent to demand payment; 2) vote against or abstain from voting for the fundamental corporate change; 3) shareholder must demand payment and the corporation must pay the fair value of the shares.

10b-5 Tipper

The Supreme Court has held that a corporate insider who breaches a duty not to use inside information for personal benefit can be held liable under rule 10b-5. Typical securities insiders such as directors, officers, controlling shareholders, and employees of the issuer are deemed to owe a duty of trust and confidence to their corporation that is breached by trading on inside information. This duty is breached 1) when the insider trades on the inside information or 2) when the insider gives a tip of inside information to someone else who trades on the basis of that information, if the tip was made for an improper purpose.

Piercing - Fraud

The corporate veil may be pierced where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligations. However, incorporators will not be held liable for using the corporate form to avoid future liabilities, as this is the hallmark of the corporate form.

Piercing - Inadequate Capitalization

The corporate veil may be pierced where the corporation is inadequately capitalized. A corporation is inadequately capitalized if, at the time of formation, there is not enough unencumbered capital to reasonably cover prospective liabilities.

Rule 10b-5

Under Rule 10b-5, it is unlawful for any person, directly or indirectly, by the use of any means of interstate commerce to, in connection with the purchase or sale of any security 1) employ any device, scheme, or artifice to defraud; 2) make any untrue statement of a material fact or omit to state a material fact; or 3) engage in any act, practice, or course of business that would operate as a fraud. A prima facie case for breach of the rule requires proof of 1) fraudulent conduct; 2) in connection with the purchase or sale of a security; 3) use of a means of interstate commerce, and in some cases; 4) reliance, 5) damages in private causes of action.

Corporation by Estoppel

Under the common law doctrine of corporation by estoppel, persons who have dealt with the entity as if it were a corporation will be estopped from denying the corporation's existence.

Piercing the Corporate Veil

Under the doctrine of piercing the corporate veil, courts disregard the corporate entity and hold individuals personally liable for the corporation's obligations if the privilege of conducting business as a corporation has been abused. A court may pierce the veil if 1) the corporate formalities have been ignored and injustice results (the alter ego theory); 2) the corporation was inadequately capitalized at the time of formation; and 3) the corporate form is being used to perpetrate fraud. If the veil is pierced, shareholders will be held jointly and severally liable.

10b-5 Misappropriation

Under the misappropriation doctrine, the government can prosecute a person under rule 10b-5 for trading on inside market information, i.e., information about the supply or demand for stock of a particular company, in breach of a duty of trust and confidence owed to the source of the information.

Piercing - Alter Ego

Where the corporation ignores corporate formalities such that it may be considered the "alter ego" of the shareholders the corporate veil may be pierced. This situation may arise when shareholders treat corporate assets as their own or fail to observe corporate formalities and injustice results.

Shareholder Suits

● Direct Action: A shareholder may bring a direct action for breach of a fiduciary duty owed to the shareholder by an officer or director. Recovery goes to the shareholder. ● Derivative Action: A shareholder may bring suit to vindicate the corporation's rights in a derivative action. Recovery goes to the corporation. To bring a derivative suit, the shareholder must 1) be a shareholder at the time of the conduct complained of; 2) the shareholder must adequately represent the interests of the corporation; and 3) the shareholder must make written demand on the corporation. Demand may not be required if it would be futile, i.e., where the majority of directors are interested. If demand is required and a majority of disinterested directors find in good faith after a reasonable inquiry that the suit is not in the corporation's best interests, the suit may be dismissed.