Corporations and LLCs Rule Statements MEE

Derivative suits

A derivative suit is appropriate when the injury is caused to the corporation and a shareholder is trying to enforce the corporation's rights. (This also applies to LLCs.)

Duty of loyalty

A director must act in good faith and with a reasonable belief that what he does is in the corporation's best interest. The business-judgment rule presumption does not apply if there is a duty of loyalty issue.

Lawsuits by shareholders against the corp

A shareholder may file an action to establish that the acts of the directors are illegal, fraudulent, or willfully unfair and oppressive to either the corporation or the shareholder. Whether a suit is appropriately brought as a direct or derivative action depends on the injury.

Filing a derivative lawsuit, extra requirements

A shareholder may not commence or maintain a derivative suit unless three requirements are met (mnemonic=SAD): (1) standing to bring a lawsuit, (2) adequacy (the shareholder represents the interests of the corporation), and (3) demand (generally, the shareholder should file a written demand and wait 90 days before filing suit unless irreparable injury would result or demand would be futile). Standing requires the shareholder to be a contemporaneous owner at the time of the alleged act or omission. A derivative suit can be dismissed with court approval if it's not in the best interest of the corporation to continue it.

Voting by proxy

A shareholder may vote by proxy. A shareholder can appoint a proxy in writing by signing an appointment form or making a verifiable electronic transmission. A proxy is generally revocable (even if it states it's irrevocable), and any action inconsistent with the grant of a proxyworks to revoke it. Thus, when 2 or more revocable proxies are given, the last given proxy revokes all previous.

Direct suits

Adirectsuitisappropriatewhenthewrongdoneamountstoabreachofduty owed to the individual personally. (E.g., shareholder sues for denial of preemptive rights, payment of a dividend, or oppression in a close corporation.) Recovery from a derivative lawsuit goes to the corporation, not the shareholder.

LLC formations, rights, and duties

Articles of organization must be filed to create an LLC. Since LLCs are a relatively new form of business association, courts tend to analyze them in the context of corporate or partnership law. Members of an LLC have fiduciary duties. Members of an LLC in a member-managed LLC are treated as agents of the LCC (with actual and apparent authority to bind the LLC in ordinary—but not extraordinary—affairs).

A duty of loyalty issue arises in three ways (mnemonic=BCC):

Director is on Both sides of a transaction: a director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract. Competes with corporation: a director may not compete with his corporation. Corporate opportunity: a corporate officer may not usurp a corporate opportunity.

Directors

Directors manage the corporation and (like shareholders) act as a body by voting. Directors may exercise all corporate powers that are not limited by the articles of incorporation or a shareholders' agreement, including the power to form contracts and acquire liabilities. Shareholders hire and fire directors. Directors cannot vote by proxy or agreement. A quorum (majority of directors) needs to be present for a vote to take place, but unlike shareholders, directors can "break quorum" by leaving. Notice is required only for special meetings.

Liability

Generally, individual members are not liable for losses. They are liable if the court decides to pierce the LLC veil (discussed above) or if proper procedures for dissolution and winding up have not been followed. (Creditors may enforce claims against each of the LLC members. However, a member's total liability may not exceed the total value of assets distributed to the member in dissolution.)

Lawsuits against shareholders-piercing the corporate veil

Generally, the law treats a corporation as an entity separate from its shareholders, even where one individual owns all the corporate stock. In some (very limited) circumstances, courts will disregard the LLC form and hold a shareholder personally liable for corporate debt. To do so is called piercing the corporate veil. It is only allowed in close corporations and LLCs. Generally, a plaintiff must show that shareholders of the corporation or members of an LLC abused the privilege of incorporating and fairness requires holding them liable. One generally needs to show undercapitalization of the business, failing to follow formalities, commingling of assets, confusion of business affairs, or deception of creditors. Only the shareholders or members who participated in the wrong are personally liable.

The duty of loyalty and duty of care

Heavily tested. Whether a director of a corporation (or member of an LLC) breached the duty of care or loyalty is very fact-based. However, usually when duty of loyalty is an issue, the director or member has breached the duty.

Shareholders

Shareholders are only owners and do not manage the corporation. Thus, they generally just have annual meetings. Written notice of meetings is required 10-60 days prior and must state the time, place, and purpose of the meeting. Shareholders can vote by proxy (have someone vote their shares for them) or by voting agreement. Generally, a quorum (majority of all outstanding shares required to vote) must be present to hold a vote

Defenses to liability for breach of the duty of loyalty

The Revised Model Business Corporation Act (MBCA) includes three safe harbors that may protect a director who breaches his duty of loyalty: (1) approval by disinterested (qualified) directors (if all relevant information is disclosed), (2) approval by disinterested (qualified) shareholders, or (3) if the transaction is judged to be fair to the corporation at the time it was entered into. A qualified director is a director without a conflicting material interest. Qualified shares are those not held by a conflicted director or related person.

Incorporation

The articles of incorporation are filed with the state, and, if in conflict with bylaws, the articles control. A corporation is not generally liable for a contract entered into prior to incorporation unless it expressly or impliedly adopts (ratifies) the contract. The promoter (person entering the contract on behalf of the to be formed corporation) is liable.

Who votes?

The record owner on the record date.

Duty of care—business-judgment rule:

There is a presumption that "in making a business decision, the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company." Directors must be informed to an extent that they reasonably believe is appropriate. They are entitled to rely upon information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc., in making a decision. A party claiming that the directors breached their duty of care has the burden of proof.

Waiver of duty in an LLC

an LLC operating agreement may waive the duty of loyalty (e.g., allow members to open competing businesses) so long as it is not "manifestly unreasonable."

Exception: a proxy is not revocable if it

explicitly states it's irrevocable and is coupled with an interest (e.g., sale of shares). Many states say a proxy is valid for 11 months unless otherwise stated.

a shareholder has a right to inspect corporate books and records as long as

his demand is made in good faith and for a proper purpose. A proper purpose is a purpose reasonably related to a person's interest as a shareholder (e.g., shareholder articulates a purpose to address "economic risks" to the corporation). A shareholder must state (1) his purpose, (2) the records he desires to inspect, and (3) that the records are directly connected to his purpose.

Dissociation

if a member leaves, then it leads to dissociation of that member, but it does not lead to winding up or dissolution unless the other members unanimously agree to dissolve the LLC.

voting

in order for a resolution to pass, there needs to be a quorum present, and more votes must be cast in favor of the resolution than against it.