Corporations

Non-Insider Trading Claims based on 10b-5

* covers any kind of deception involved in transaction of any security 1. misrepresentations & omissions in: a. face to face transactions (non public market sales) b. press releases c. fraud on the corporation 2. stock manipulation schemes

CIRCUMSTANCES UNDER WHICH COURTS WON'T PIERCE THE CORPORATE VEIL

In the following situations, courts generally will not hold shareholders liable for corporate obligations: 1. Closely held corporations (i.e., with one or a few shareholders): Courts will honor the corporate veil as long as there's no fraud or wrongdoing, the business is conducted on a corporate (not personal) basis, and the corporation had adequate initial capitalization. 2. Parent-subsidiary (or affiliated) corporations: Courts won't hold the parent liable for the subsidiary's obligations if there's no fraud or wrongdoing, there's no intermingling of respective business transactions, accounts and records, the subsidiary was adequately financed in light of normal obligations foreseeable in businesses of its size and character, and the parent and subsidiary are held out to the public as separate corporations.

What is the disclose or abstain rule?

duty imposed on insiders with insider information - must either disclose insider info before trading securities but if they are unable to do so they must abstain from trading

Deceived Corporation

when corporation directors approve an issuance of stock to themselves or purchase stock at an unfair price

After the articles of incorporation are filed, an organizational meeting takes place. What happens at the meeting?

1. Directors are selected (if they weren't named in the articles of incorporation). 2. The directors make initial decisions. These include accepting subscriptions to corporate stock, approving issuance of shares in return for consideration (usually money) exchanged for stock, and designating corporate officers and establishing their areas of authority. 3. Bylaws are adopted. NOTE: If the directors were named in the articles of incorporation, the organizational meeting is called an "organizational meeting of directors"; if not, it's called an "organizational meeting of incorporators."

What 4 classes of people can be liable for insider trading?

1. Pure insiders 2. temporary insiders (lawyers, accountants, etc) 3. Misappropriaters (trades on the basis of info stolen from someone who owes a fiduciary duty) 4. Tippees (not an insider but someone to whom information was disclosed)

What's the difference between a public corporation and a close corporation?

A public corporation is a corporation with widespread ownership that is actively traded. A close corporation, on the other hand, has few owners, as well as stock that isn't traded on a national exchange or otherwise actively traded, and has significant overlap between management and shareholders. Some states have statutes defining close corporations precisely.

What is an ultra vires act?

A transaction that is outside a corporation's purpose or powers. The scope of a corporation's purpose and powers is determined both by the corporation's articles of incorporation and the state's corporate statute. SIGNIFICANCE: Not much today; however, traditionally ultra vires acts were considered void. This came up most frequently in the case of contracts, which were unenforceable by or against the corporation if they were outside the corporation's powers (e.g., not in relation to the corporation's stated purpose). Even for acts that were theoretically ultra vires, exceptions were typically made if either party had already performed under the ultra vires contract. HA §184 pp. 478-79. EXAMPLE: Lexicon Luthor Inc.'s articles limit its corporate purpose to publishing. It enters the insurance business. Insurance is outside Lexicon's purpose, so the insurance business is ultra vires, such that, under the traditional rule, anyone contracting with Lexicon's insurance business couldn't enforce such contracts against Lexicon and Lexicon couldn't enforce them either (unless either party had already performed, in which case an exception would likely be made).

Forming a corporation requires, in essence, filing articles of incorporation with the secretary of state in the state of incorporation. What do the articles of incorporation contain?

According to MBCA §§2.02(a) and 6.01, the articles must include: 1. the corporate name (which must indicate corporateness—e.g., "Inc.," "Co."; furthermore, the name must be distinguishable from that of any other corporation formed or registering its name in the state), 2. the number and types of shares the corporation may issue (e.g., preferred, common), 3. the address of the corporation's registered office, 4.the name of the corporation's registered agent at the registered office, and 5. each incorporator's name and address. MNEMONIC: A RAINS (Address; Registered Agent; Incorporators; Name; Share information). NOTE: In addition, the articles may contain optional provisions, including: - the corporation's purpose (if this isn't included, the corporation is deemed to have the purpose of engaging in "any lawful purpose," MBCA §3.01(a)), - names and addresses of the initial board of directors, - "par value" of shares of stock, - any provision that must or may appear in the corporation's bylaws, and - limitations on the liability of directors for certain breaches of duty. NOTE: Only some states require a corporate purpose clause. In most of those that do, it's enough to say that the corporation may engage in any lawful activity for which corporations may be organized (although the articles may limit the purpose). MBCA §2.02(b).

What are the remedies for an ultra vires act?

Although they vary from state to state, they're typically limited. MBCA §3.04, which is representative of ultra vires statutes, holds that the following remedies are possible: Injunction. May be sought by: A shareholder seeking to prevent the corporation from carrying out an ultra vires act. The injunction will be issued only if it is equitable. If the injunction is granted, an injured party may recover damages due to non-completion of the contract other than lost profits. The state seeking to enjoin the corporation from undertaking unauthorized business. Damages. Can be sought by the corporation itself (or a shareholder in a derivative suit) from the officers, directors, or employees responsible for the ultra vires act. Damages can reflect any damage to the corporation stemming from an already-performed ultra vires contract. Dissolution. The attorney general of the state can seek dissolution of the corporation on grounds of an ultra vires act. NOTE: Neither the corporation itself nor a third party can disavow a contract on ultra vires grounds.

When a corporation's formation substantially complies with the state's corporation statute—that is, its articles of incorporation are duly executed and filed, and they're accepted and recorded by the secretary of state—what's the corporation's status?

De jure corporation

Grissom is the president of C S Eye, Inc., which is incorporated in Nevada. Most of the directors of C S Eye live in New York, as do Grissom and most of the company's employees. Florida is where most of C S Eye's business is conducted. Its shareholders and customers live in all 50 states. If the directors decide to remove Grissom as president, what law will govern?

Easy question! Nevada law will govern the power of the board to remove Grissom as president, because it is the law of the state of incorporation. NOTE: Grissom may have long-term contract or other rights as an employee of CS Eye, Inc. These would not necessarily be governed by Nevada law. For instance, if he believes he is being discriminated against because he is hard of hearing, he might have a claim under federal law.

Why would a corporation want to be a close corporation?

Flexibility. Statutes (and, in some states, common law) give close corporations a flexibility of governance not available to "regular" corporations.

What is a promoter?

It is a person instrumental in launching a corporation, who typically remains involved with the corporation once it's formed (e.g., as a director or shareholder). A promoter: - locates interested investors; - finds needed personnel and property; and nurtures the idea or product that is the corporation's focus. SIGNIFICANCE: The principal issue concerning promoters arises when a corporate promoter enters into contracts on a corporation's behalf before the corporation comes into existence (i.e., before articles of incorporation are filed), and it's this: who is liable for breach of these pre-incorporation contracts—the promoter, the corporation, or both?

Under what circumstances is a promoter liable for a breach of a pre-incorporation contract he makes on a corporation's behalf?

It usually depends on whether the promoter discloses that the corporation doesn't exist and whether he makes it clear he's contracting only on the corporation's behalf. Promoter enters into contract on corporation's behalf without disclosing that corporation doesn't exist—promoter is liable personally. Promoter enters into contract on corporation's behalf, acknowledging that corporation doesn't yet exist under circumstances in which the other party impliedly agrees not to hold the promoter liable—only the corporation is liable. Quaker Hill v. Parr, 364 P.2d 1056 (CO 1961). Promoter enters into contract on corporation's behalf, acknowledging that corporation doesn't yet exist and without making it clear that he's contracting on the corporation's behalf—promoter is liable personally, especially if the contract requires performance prior to formation of the corporation. NOTE: If the promoter is liable, he remains liable even if the corporation, when formed, adopts the contract, unless there is a novation—that is, the party with whom the promoter contracted agrees to release him from the contract. HA §111 pp. 255-56, §112 pp. 257-58. NOTE: If the promoter is required to pay under a pre-incorporation contract, he is entitled to reimbursement from the corporation to the extent it benefited from the contract.

People can conduct business without forming a corporation. What's the principal reason they would want to form a corporation?

Limited liability. What this means is that when people conduct business by creating a corporation, if the corporation becomes insolvent, the individual shareholder will usually lose only the amount already paid for his stock (there are exceptions to this rule). C §1.2.1 p. 7. NOTE: Here are the major exceptions to the rule, where shareholders can be liable beyond their investment: 1. If a "close" corporation's shareholders sign personal guarantees on loans others make to the corporation, such that, if the corporation doesn't pay, the guaranteeing shareholder must do so. 2. If a creditor has grounds for "piercing the corporate veil" and making shareholders liable for corporate debts

Marie Antoinette, a promoter for the not-yet-formed Let 'Em Eat Cake Baked Goods Co., signs a requirements contract on the company's behalf with the Wilted Flour Co., covering all the company's flour needs for the next three years. Under what circumstances will Let 'Em Eat Cake, once it is formed, be liable under the contract?

Only if it: 1. expressly adopts/ratifies the contract (via resolution by the board of directors); 2. impliedly adopts/ratifies the contract (i.e., by receiving goods as per the contract, with knowledge of the contract's terms); or 3. accepts goods under circumstances making it inequitable for the company to retain the goods without paying for them.

Under what circumstances will courts allow creditors to pierce the corporate veil and hold individual shareholders personally liable for corporate debts?

MNEMONIC: Ferdinand Found Fish In Cleveland (Fraud; Few shareholders; Formalities; Inadequate Capitalization). There's no simple answer, since courts vary widely as to when it's appropriate to pierce the corporate veil; generally, they're wary of doing it at all. As a general rule, however, some of the following factors must be present (any one factor, other than fraud, won't suffice): 1. Nature of shareholder(s) in question: Much more likely for non-public companies with few shareholders (the veil of public companies is almost never pierced), and, even hen, only for shareholders who are active in the business (instead of passive); 2. Existence of fraud or wrongdoing (e.g., shareholder siphons profits from corporation; shareholder holds self out as liable personally for corporate debts; corporation formed to evade existing obligations); 3. Failure to follow corporate formalities (e.g., shareholder commingles own funds with the corporation's or uses the corporation as a mere conduit for personal business activities; the corporation fails to issue shares or hold directors' meetings); 4. Inadequate initial capitalization (i.e., shareholders didn't put in money commensurate with the corporation's prospects and risks). A failure to maintain capitalization (e.g., by removing too much cash from an existing business), usually counts as fraud or wrongdoing.

Jim Kirk is president of a closely held corporation, Tribble Trouble Inc., which owns a tribble ranch where it raises fuzzy little tribbles that are sold as exotic housepets. He phones Mr. Spock, a neighbor who is also a Tribble Trouble shareholder, and tells him the ranch is having breeding troubles, and the outlook isn't very good. He encourages Spock to sell him his shares for $50 each. Spock does so. In fact, the tribbles are reproducing like rabbits, and Spock's shares were really worth $200 each. When Spock finds out about Kirk's lie, he gives Kirk a Vulcan neck pinch at the next block party, and then files a 10b-5 claim against him in federal court. Kirk challenges the claim on grounds of lack of jurisdiction. Is he correct?

NO federal courts have jurisdiction over 10b-5 claims

Does 10b-5 only apply to stocks of publicly traded companies?

NO it applies to all companies but most common in public companies

Gilligan's Island Tours, Inc., runs cruises. Its purpose, as stated in its articles of incorporation, is limited to running such cruises. Realizing that a desert island to which it sails would make a great resort, the chairman of the board of Gilligan's Island Tours, Skipper, signs a land sale contract on the corporation's behalf to purchase the island. Ginger, a major shareholder of Gilligan's Island Tours, challenges the proposed purchase on ultra vires grounds. Is the purchase ultra vires, according to the modern courts?

No, even though the articles of incorporation limit the corporation's purpose to running cruises. Ultra vires acts are those beyond the scope of the corporation's powers and purposes. Modern courts imply corporate powers across a broad range. As a general rule, corporations have the implied power to engage in any act reasonably necessary to accomplish their express purposes. In the facts here, opening a resort would be considered incidental to the corporation's purpose of running cruises and within the scope of Gilligan's Island Tours' implied powers. As a result, it wouldn't be considered ultra vires.

Does a corporation need to have a corporate seal?

No, it doesn't have to have one. However, if the corporate seal is affixed to a document, it sometimes is regarded as prima facie evidence that the corporation has approved the transaction and of the authority of the person who signed it. The corporation's secretary (or other officer serving the secretary's function) generally is the proper person to affix the seal.

Is a promoter the same thing as an incorporator?

No. A promoter performs various services in launching a corporation, including finding business opportunities, making financing arrangements, arranging for the incorporation services of an attorney, etc. An incorporator's only functions are to sign the articles of incorporation before they are filed and to elect the corporation's initial board of directors (if they aren't named in the articles). A corporation's incorporator(s) may be the lawyer who formed the corporation, a paralegal or secretary in the lawyer's office, an employee of a professional incorporation service, or a promoter! By itself, the fact that a person is an incorporator doesn't make him a promoter.

Must the corporation's initial board of directors be named in the articles of incorporation?

No; the articles may name the initial directors, but if they don't, the directors may be named at the corporation's "organization meeting" (which takes place after the articles of incorporation are filed). If the directors are named in the articles of incorporation, then the organizational meeting is called the "organizational meeting of directors"; if not, the initial directors are appointed at the organizational meeting, which is called the "organizational meeting of incorporators."

Neo was planning on entering into an architectural services contract on behalf of Matrices, Inc., a corporation that he has owned for a long time. At the last minute, he decides that he will form a new corporation to enter the contract. He strikes the references to Matrices, Inc., and in each place substitutes "Matrucks, Inc., a corporation to be formed." He tells the architect that this is what he has done, and asks if that is alright. The architect has no objections. It takes a while for Neo to get Matrucks formed, and he never quite gets it running. Is Neo personally liable on the contract?

Probably. The general rule is that a promoter who enters into a contract on behalf of a corporation that is known to the other party to be non-existent is liable unless there is an express or implied agreement to the contrary. There do not seem to be any facts showing that the architect has agreed to the contrary, so Neo will be bound. This conclusion would be strengthened if the contract called for payments to the architect before Matrucks might be expected to come into existence.

How do you go about forming a corporation?

Simply put: You file for one. You follow the corporate statute in the state in which you incorporate, which basically requires that the "incorporators" file a document called articles of incorporation with a designated state officer (usually the secretary of state), and pay statutory filing fees. N p. 48; HA §117 p. 267. NOTE: Although state requirements vary, the Model Business Corporation Act (MBCA), as revised to date, is fairly typical, and that's what we'll use for a reference point in this topic. NOTE: Although filing the articles of incorporation completes the creation of the corporation, its structure isn't complete until certain basic matters are taken care of, either at an organizational meeting of the board (if the board is named in the articles of incorporation) or at an organizational meeting of the incorporators (if the directors aren't named in the articles). Steps taken at this meeting typically include naming directors (if they aren't named in the articles), adopting bylaws, electing corporate officers, adopting a corporate seal (not the zoo kind) and stock certificate, authorizing shares to be issued to stated people at a stated price, and designating a corporate bank.

Al and Peg Bundy open up "Married...With Problems," a marriage counseling service. They want to incorporate the business. What kind of information about ownership of the corporation must appear in the articles of incorporation?

The articles of incorporation must describe corporate ownership, or "stock," in terms of: 1. the types of stock the corporation is authorized to issue (e.g., preferred, common); and 2. the number of shares of each class of stock the corporation may issue. (Note that this should be more than the corporation initially plans to issue, in case it wants to issue more shares in future (e.g., to raise more capital). If the corporation doesn't authorize more shares than it plans to issue, any increase in authorized shares requires a shareholder approved amendment to the articles.) MBCA §§2.02(a) and 6.01. NOTE: The articles may also include more details on ownership, including: - whether or not the stock has "par value;" and - the privileges, rights, and preferences each class of stock is to have. MBCA §§2.02(b) and 6.01.

Scrooge McDuck is the majority shareholder of the Huey Dewey Louie Real Estate Development Corp. The company makes a $19 million profit one year. McDuck donates $500,000 of it to a nonprofit charity he controls, the McDuck Foundation for the Preservation of Wetlands. A state statute authorizes corporations to make reasonable charitable gifts by corporations. If a minority shareholder challenges the donation as ultra vires, what result?

The gift is valid, as long as it's in the corporation's interests (and not purely for McDuck's own personal benefit). Ultra vires acts are those outside the corporation's powers and purposes. The scope of a corporation's powers is determined by its articles and state statutes. Here, the state authorizes reasonable corporate charitable gifts (this is a typical statute). MBCA §3.02(13). With a $19 million profit, $500,000 is reasonable. Note that it's relevant that McDuck controls the charity in question, but it doesn't change the result. (If the charity was a sham, or McDuck was making the gift for personal instead of corporate interests, the issue would be self-dealing, not ultra vires.) RELATED ISSUE: Say that the company's articles expressly forbade charitable gifts. Such a gift would be ultra vires.

One common ground for piercing the corporate veil is fraud or wrongdoing. What kinds of things constitute fraud or wrongdoing?

The most common type is shareholders siphoning off of company profits, leaving too little cash to satisfy corporate creditors. Others include things like misrepresentation of the corporation's assets, or a shareholder holding himself out as liable personally for corporate debts (e.g., not making it clear to a creditor that he doesn't intend personally to back up corporate debts).

Why isn't ultra vires a very hot topic nowadays?

There are three reasons. 1. Most states have abolished ultra vires in contract cases involving third parties who've done business with the corporation. Since this was traditionally its main application, this change sucked much of the vitality out of ultra vires. Furthermore, modern courts imply a broad range of powers to corporations, the scope being any act reasonably necessary to accomplish their express purposes (e.g., to enter partnerships, make charitable contributions, and guaranty others' debts). 2. Most corporations today operate under statutes allowing them to have any lawful purpose and do anything lawful that is reasonable furtherance of their business. Thus, for most corporations, an act can't be ultra vires unless it's either illegal or unreasonable. 3. Even for acts that slip through the cracks and are technically ultra vires, there are strict limitations on usage. For one thing, it's not available at all in tort and criminal cases. In contract actions, it can only be raised by: (a) A shareholder of the corporation, seeking to enjoin performance of the ultra vires contract. The injunction will be granted only if doing so would be equitable. If an injunction is granted, an injured party may recover any damages due to non-completion of the contract other than lost profits. (b) The state, seeking to enjoin the corporation from undertaking unauthorized business or seeking to dissolve the corporation. (c) The corporation (or a shareholder in a derivative suit) can sue the officers, directors, or employees responsible for the ultra vires act for any damages to the corporation stemming from an already-performed ultra vires contract. NOTE: The principal areas in which ultra vires issues arise today are charitable or political contributions (OK if reasonable), fringe benefits (e.g., retirement and stock option plans; generally OK if reasonable and no self-dealing involved), and loans to officers and directors (watch for self-dealing issues). HA §184. However, the Sarbanes-Oxley Act of 2002 has made it illegal for a publicly traded company to make loans to its directors or executive officers.

What is the purpose of corporate bylaws?

They regulate many of the corporation's internal affairs. Generally, they deal with matters like the date of the annual shareholders' meeting, calling and conducting shareholders' and directors' meetings, titles and duties of officers, number of directors, and any special quorum or voting requirements. WHO CREATES: Bylaws are adopted, amended, or repealed by majority approval of either the board of directors or the shareholders entitled to vote. MBCA §10.04(a)(1). TECHNICAL REQUIREMENTS: No filing is required; unlike the articles of incorporation, the bylaws needn't be filed with the state.

"M" wants to incorporate her detective agency, "Her Majesty's Secret Service." The corporate statute in the jurisdiction requires that M designate a state resident as a registered agent. As her agent, M chooses Bond—James Bond. What's the purpose of the "registered agent" requirement?

To receive service of process on behalf of the corporation in case it's sued by anyone on any claim. Note that the registered agent's name and address must appear either in the articles of incorporation or in a separately filed form

Benjamin Disraeli intends to form a corporation, Sceptered Isle Tableware, to manufacture salt and pepper shakers in the shape of British kings and queens. Disraeli fills out the articles of incorporation correctly, and has his lawyer file them with the Secretary of State for the state of Thames on December 1. On December 10, Disraeli, as president of Sceptered Isle, signs a lease on some manufacturing space owned by Victoria Regina. On December 15, the Thames Secretary of State accepts Sceptered Isle's articles. Sceptered Isle subsequently defaults on the lease. When Victoria Regina goes after Disraeli personally, what result?

Under the MBCA, articles are "filed" when they are recorded by the secretary, but the effectiveness of the filing is retroactive to the time that they were received. MBCA §§1.21 and 1.25. Thus, Disraeli isn't personally liable. Corporation by estoppel would also apply, because Victoria Regina dealt with Disraeli believing (as did Disraeli) she was contracting with Sceptered Isle, so she couldn't thereafter deny its existence.

The common law defenses de facto corporation and corporation by estoppel both shield shareholders from liability due to defects in forming the corporation. What's the most important difference between the two?

Who they can be used against. The de facto corporation defense protects shareholders from liability to all parties (although the corporation's status can be challenged by the state). Corporation by estoppel defends shareholders against only those third parties who've dealt with the corporation believing it to be a proper (de jure) corporation. It can't be used, for instance, against anyone with a tort claim against the corporation, or involuntary creditors, neither of whom dealt with the business as a corporation.

Snoopy, tired of begging for his dinner, decides to earn money to buy his own food. He opens up a movie production company. The first feature he intends to produce is "My Life as a Human." He files articles of incorporation, in which he states that the company's purpose is "to engage in any business in which corporations are allowed to engage." All Snoopy intends for the corporation to do is make movies. If the jurisdiction requires a purpose statement in the articles of incorporation, is Snoopy's purpose statement permissible?

Yes, in most jurisdictions. Not every jurisdiction (nor the MBCA) requires a purpose statement at all. Of those that do, in most jurisdictions this statement can be very general, like Snoopy's. (Delaware, for instance, doesn't require anything specific. Del. Ann. Code 102(a)(3).)

Are there any limitations on the name that can be chosen for a corporation?

Yes, there are three: 1. SIMILARITY: The corporation's name must be distinguishable from the name of any other corporation formed or registering its name in the state. 2. CORPORATENESS: In most states, a corporation's name must show that it is a corporation, by including "Co.," "Inc.," or something similar. 3. NO ILLEGAL PURPOSE: A corporation's name must not suggest that it will engage in some business it can't legally conduct (e.g., banking if it's not a regulated bank). NOTE: A corporation's name must appear in its articles of incorporation.

Oliver Wendell Douglas, a promoter for the yet-to-be-formed Hooterville Produce Co., contracts to buy a 160-acre farm on Hooterville Produce's behalf from Mr. Haney. He signs the land sale contract without making it clear to Haney that Hooterville Produce does not exist yet. The closing is set for August 1. Hooterville Produce is formed one month before that. The board, consisting of Hank Kimball, Fred Ziffel, and Sam Drucker, ratifies the land sale contract. Shortly thereafter, Hooterville Produce becomes insolvent. Can Haney hold Douglas personally liable on the land sale contract?

Yes. When a promoter contracts on a corporation's behalf before the corporation is formed, and the contract is breached, the promoter may be liable personally on the contract. Where, as here, the promoter contracts on the corporation's behalf without letting on that the corporation doesn't exist yet, he's liable personally.

Mrs. Grendel is the dominant shareholder of Great Danes Consulting, Inc., which specializes in giving advice on hostile takeovers. Grendel has no fixed salary but, rather, takes money from the company as she sees fit. Furthermore, Grendel sometimes takes consulting jobs on the side, instead of funneling them through Great Danes Consulting, Inc., to cut down on paperwork. At one point, Great Danes Consulting, Inc. is unable to pay a creditor, Mr. B.O. Wulf, who wants to go after Grendel personally for payment. Will Wulf be able to do so?

Yes. Wulf can seek repayment from Grendel personally because Grendel, as dominant shareholder of Great Danes Consulting, Inc., commingled her affairs with those of the corporation. As a general rule, corporate creditors can't seek payment directly from shareholders of a corporation; the shareholders are protected by the corporate "veil." When shareholders don't merit protection by the "veil," however, creditors may pierce the veil and seek payment from them personally. One such circumstance exists where a dominant shareholder commingles her affairs with those of the corporation and siphons profits from it. This is one of the ways the corporation can be considered the shareholder's "alter ego." Here, with no fixed salary and diverting money and business to herself personally, Grendel fits this description. As a result, Wulf, as a corporate creditor, can seek payment from Grendel personally.

What is a corporation?

a fictitious being, independent of its owners, that can conduct business in its own name.