Business Law2

Chapter 8 Corporate Directors, Officers and Shareholders

A. Corporate Governance: Board of Directors and Officers 1. A corporation is governed by a board of directors elected by shareholders. The Board as a group (not individually) binds the corporation. Directors usually appointed at first organizational meeting. It's common practice to elect one-third of the board members each year for a three-year term so that you don't get a completely new board all at once ("staggering the board"). Directors have rights to attend all meetings, inspect the books. 2. An inside director is also an officer of the corporation. An outside director does not hold a management position in the company. Boards usually have both. The Board of Directors doesn't run the day-to-day job of the company. 3. Board of Directors' Meetings are used to conduct business by holding formal meetings with recorded minutes. Unless otherwise stated in the articles of incorporation or bylaws, a majority of the board of directors normally constitutes a quorum that is needed to conduct a meeting. Once a quorum is present, the directors transact business and vote on issues affecting the corporation. Each director present at the meeting has one vote. Majority vote wins. A Director can formally dissent if he disagrees with action of the majority of Board. Ex. If a Board has 10 directors, at least 6 must be present at a meeting to constitute a quorum. Of those 6, at least 4 must vote the same way to pass anything at that meeting. 4. Directors are the ones who hire the Officers of the company who actually do the day-to-day running of the company. Officers are agents and employees of the company. B. Duties and Liabilities of Directors and Officers: 1. They are fiduciaries of the company and owe two important ethical and legal duties to it: a. Duty of Care: Requires them to act in good faith (honestly), exercise care of ordinarily prudent (careful) person and do what they feel is in best interests of company. This includes duty to make informed decisions (do investigation and get all info before making a decision) and duty to exercise reasonable supervision (keep an eye on the officers' work). Business Judgment Rule: Protects a director or officer from liability from bad decisions as long as decision was reasonable, informed, and made in good faith and in the best interests of the corporation. It won't apply if there is evidence of bad faith, fraud, or a clear breach of fiduciary duties. b. Duty of Loyalty: Requires them to put the interests of the corporation ahead of their own personal interests. This means: · No competition with corporation. · No "corporate opportunity." · No conflict of interests. Director or officer must make a full disclosure of any conflicting interest · No insider trading. C. The Role of Shareholders: 1. Owning shares gives you an equity interest in the company. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. 2. Shareholders vote on significant and fundamental changes to corporation: amend by-laws or charter, mergers or acquisitions, sale of all assets, dissolution, elect and remove directors. 3. Shareholder Meeting: Shareholders must meet at least annually (once per year). Shareholder can give someone else his proxy to vote his shares for him as an agent at the meeting. Shareholders can submit a proposal to the board of directors and ask the board to include the proposal in the proxy materials that are sent out before meetings. 4. Voting: Need shareholders representing at least 50% of the shares at the meeting to conduct business (quorum). Voting techniques: a. Cumulative Voting: Each shareholder is entitled to a total number of votes equal to the number of board members to be elected multiplied by the number of voting shares that the shareholder owns. Allows minority shareholders to be represented on the board of directors. Ex. Each shareholder gets one vote for each Director slot to be filled. If there are three seats open, that's three votes for each shareholder. A shareholder can use all three at once to vote for one candidate that he likes so he can make sure he is represented. b. Shareholder voting agreement: Before a meeting, a group of shareholders can agree in writing to vote their shares together in a specified manner. D. Rights and Duties of Shareholders: 1. Right to receive dividends: Distribution of corporate profits or income to shareholders based in proportion to their shares. A dividend can be paid in cash, property, or stock (company's own or another corporation). 2. Right to examine specified corporate records for a proper purpose 3. Preemptive Rights: Allows each shareholder to maintain his proportional control of the company. Ex. If shareholder owns 50% of the corporation and the corporation decides to issue 100 more shares, the shareholder has the right to buy as many shares as would still keep him at 50% ownership before someone else can buy them. 4. Right to bring a Shareholder's Derivative Suit: A lawsuit brought by shareholders against a third party that has harmed the company when the corporate directors have failed to bring a suit against that party. Any award goes to the corporation, not the shareholder who brought the suit because he was suing on behalf of the corporation. *Important: A shareholder's derivative suit can be brought against directors or third parties. 5. Watered Stock: Shares that a corporation issues for less than their fair market value. This is not allowed. Ex. John gives the corporation a property worth $2 million, but he gets $4 million worth of shares; the stock is watered down. 6. Majority Shareholders: Own enough shares to basically control the corporation; de facto (actual) control. They owe a fiduciary duty to the corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control.

Chapter 9 Mergers and Takeovers

A. Merger: The legal combination of two or more corporations, after which only one company exists and it possesses all the assets, rights and obligations of the other corp. (A+B=A; A is the surviving corporation). B. Consolidation: When two or more corporations combine in such a way that each corporation ceases to exist and a brand new one emerges that possesses all assets, rights and obligations of both of the original ones. (A+B=C; C is the consolidated corporation). C. Share Exchange: Some or all the shares of one corporation are exchanged for some or all the shares of another corporation. If one corporation owns all the shares of another corporation, it is referred to as the parent corporation, and the wholly owned company is the subsidiary corporation. **For all three above, the board of directors and majority of the shareholders of each corporation involved must approve the merger or share exchange plan. D. Short-form Merger: When a parent corporation owns at least 90 percent of the outstanding shares of each class of stock of the subsidiary corporation, then a short-form merger is allowed without the approval of the shareholders of either corporation. E. Dissenting Shareholders: A shareholder who doesn't agree (except short-form) won't be forced to own shares in new entity. He is entitled to appraisal rights: right to be paid the fair value of the shares they held on the merger or consolidation date (value as of the day before the merger) F. Sale and Purchase of Assets: If a corporation is the one selling all its assets to another corporation, it's almost like a merger, and so it must obtain approval from both its board of directors and its shareholders. If a corporation is the one purchasing the assets of the other corporation it does not need to get shareholder approval and the purchaser doesn't take on all the debts/obligations of the seller. G. Corporate Takeover/Purchase of Stock: A corporation can also take control of another corporation ("target corporation") by purchasing a substantial number of its shares. Tender Offer: The buyer goes directly to the shareholders of the target corporation to buy their shares from them (cash or stock), usually at a higher than market price. a. Friendly Merger: If management of the target thinks it's a good deal b. Hostile Takeover: If management of target opposes the takeover, they will try to fight off the acquirer, how? Use takeover defenses (to be discussed in class). However, the board of directors has a fiduciary duty to the corporation and its shareholders to act in the best interests of the company. In a hostile takeover, the directors' duties of care and loyalty may collide with their self-interest (they might lose job etc.). Shareholders can sue because they would have received a premium for their shares if the Board approved the merger. H. Termination of a corporation: Involves both dissolution (legal death of the corporation) and winding up (corporate assets are liquidated, by converting them into cash, and distributed among creditors and shareholders according to specific rules of preference. Shareholders only get paid after all creditors are paid. Termination can be voluntary or involuntary (state may step in).

Chapter 10 (42) Agency: Investor Protection, Insider Trading and Corporate Governance

A. What is a security? Almost any stake in the ownership or debt of a company can be considered a security. This includes all types of stocks and bonds, investment contracts (including interests in limited partnerships), and also interests that involve the right to purchase a security or a group of securities on a national security exchange, plus others. The "Howey test": an investment contract is any transaction in which a person (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily or substantially from others' managerial or entrepreneurial efforts (can include in real estate). B. Securities Act of 1933: governs initial sale of securities. It requires all securities transactions to be registered with the SEC (Securities and Exchange Commission) before being sold to the public, unless exempt. Purpose: prevent fraud and stabilize security industry. 1. Company files a registration statement with SEC and all investors get a prospectus (explanation of all the terms), then a waiting period while SEC reviews, if approved then can sell to public 2. Exempt Securities and Transactions: Certain types of securities are exempt from the registration requirements of the Securities Act and can generally be resold without being registered. a. Regulation A Offerings: A registration exemption is available for security offerings that do not exceed $50 million during any twelve-month period. Must give investors an offering circular. Company can test the waters to see if there is interest. Some companies have sold their securities on the Internet using Regulation A. b. Small Offerings—Regulation D: The SEC's Regulation D contains several exemptions from registration requirements for offers that involve a small dollar amount or are made in a limited manner. Includes for "accredited investors" and private placement. c. The average investor who sells shares of stock need not file a registration statement with the SEC. d. Ruel 144 and 144A resale 3. Violations of the 1933 Act: Intentional or negligent defrauding of investors by misrepresenting or omitting material information in the registration statement or prospectus, selling securities before the effective date of the registration statement or under an exemption for which the securities do not qualify. Remedies include fines, sanctions, civil suit in federal court. C. Securities Exchange Act of 1934: provides continuous periodic disclosures by publicly held corporations to enable the SEC to regulate subsequent trading. It provides regulation and registration of securities exchanges, brokers, dealers, and national securities associations. 1. Section 12 companies (over $10 million assets or 500 or more shareholders) are required to file reports with the SEC annually and quarterly and even monthly if specified events occur. 2. SEC Rule 10b(5) prohibits fraud in connection with the purchase or sale of any security. Private parties can sue under this rule for fraud. 3. Insider trading falls under violation of Rule 10b-5e. Insider trading involves the purchase or sale of securities on basis of information that is not available to the public. Tipper/Tippee Theory: Anyone who acquires inside information as a result of a corporate insider's breach of a fiduciary duty can be liable under Rule 10b-5. This liability extends to tippees (who receive "tips" from insiders) and even remote tippees (tippees of tippees). 4. Securities Fraud Online and Ponzi Schemes: Internet-related forms of securities fraud include many types of investment scams. Spam, online newsletters and bulletin boards, chat rooms, blogs, social media, and tweets can all be used to spread false information and perpetrate fraud. A Ponzi scheme is a fraudulent investment operation that pays returns to investors from new capital paid to the fraudsters rather than from a legitimate investment. D. State Securities laws: Each state has its own corporate securities laws, or blue sky laws, that regulate the offer and sale of securities within its borders. E. Corporate governance can be narrowly defined as the relationship between a corporation and its shareholders. Effective corporate governance is essential in large corporations because corporate ownership (by shareholders) is separated from corporate control (by officers and managers). 1. Stock options encourage employees to work harder because they are entitled to buy shares and resell them once the market price of a stock gets to a certain point. The problems with Stock Options include the potential that some executives have been tempted to "cook" the company's books to keep share prices higher so that they can sell their stock for a profit while others have had their options "repriced" so that they did not suffer from price declines. 2. Promoting Accountability: a. corporation must have a board of directors elected by the shareholders b. Board must have an audit committee that oversees the corporation's accounting and financial reporting processes, including both internal and outside auditors. c. Board must have compensation committee which determines the compensation of the company's officers. d. The Sarbanes-Oxley Act: The act applies to all public companies and attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for securities violations. The act also requires CEOs to take responsibility for accuracy of financial statements filed with the SEC.

Extra credit: real estate

Real Property: Land and everything permanently attached to it, plus air, water and sub-surface rights. This includes: Improvements: house, fence, landscaping, pool Fixtures: anything attached to the real property in a permanent way, for ex. plumbing, garage, windows, alarm system if installed in house, dishwasher. What about refrigerator? **put in in the contract. In a commercial setting, tenant fixtures may go with the tenant (ex. ovens, manufacturing equipment) Ownership of real property is like owning a "bundle of rights" (ex. use, sell, fix, give away) but there are limits on property ownership: nuisance, public safety, zoning laws (residential, commercial, industrial), taxes, easements (right of way). Property can be owned by one person or jointly. ​ B. Personal Property: every other property that's not real property. This can be: Tangible: furniture, tv, dishes (do not come with the real property unless specified in contract) Intangible: intellectual property, stocks and bonds C. Real Property Ownership Interests: • Statute of Frauds requires that ALL transfers of interest in land must be written (contract of sale, deed, lease, mortgage). Why? big ticket item and ownership lasts a long time so we need proof. • All documents relating to real property ownership (deeds, mortgages) are recorded in a government office to give notice to the world about who owns the property. Property right How do you get it? What does it give you? 1. Own A deed passes title (ownership) from previous owner to new owner. Deeds record the "chain of title" Fees simple (best ownership-can do the most things) 2. Rent/Lease A lease does not pass title Use and possession (can't sell or fix) D. Transfers of Real Property-what's the process?: 1. List your property (seller) or find your property (buyer) a. Seller: advertise yourself or hire a real estate broker/agent (sign a "listing agreement") to advertise and show the property to potential buyers. Broker's commission typically 5-6% of selling price of property. If hire broker, you can't cut out the agent and sell directly to someone he brought you. b. Buyer: newspaper, internet, walk the streets, word of mouth or hire a real estate broker 2. Make an offer/sign a binder a. A For Sale sign on a house or in newspaper is only an invitation to offer; buyer must make offer and seller can accept, reject or counteroffer. If they agree, they will both sign a "binder agreement" with basic information until a full contract can be drafted. b. How do we figure out the value of the property? We use the appraisal value calculated by an appraiser using: 1. market value ("comps"-compare to other same the same area) 2. cost (new construction) or 3. income (if it's a rental property) 3. Sign a Contract of Sale Contract is usually drafted by the seller's lawyer and must include: a. Legal description of the property: all states and cities have unique land identification systems: NYC uses "Block and Lot" numbers for each property; land surveys show exact dimensions and boundaries. b. Price and how it will be paid c. Type of deed d. Any personal property to be included e. Loan conditions: sign "subject to a mortgage" f. Misc. (damage, insurance, engineer's report, termite inspection) 4. Secure financing a. Where do buyers get money from? Under mattress, friends, family or get a loan b. Mortgage Broker is a professional who finds a bank to give you a loan and helps you navigate the application process. Mortgage broker usually gets 1% of the loan amount (not of the selling price of the property) c. Two parts to getting a loan (borrowing money) from a bank to buy real property: Part 1: Sign promissory note: I promise to pay you back the money (plus interest) Part 2: the promissory note is secured by a mortgage that you give the bank. The mortgage connects (links) the promissory note to the property. Mortgagor=the borrower/owner Mortgagee=the bank In a mortgage, the property serves as collateral for the promise to pay back the loan, so if you don't pay back the money the bank can take your house away. This is called foreclosure. The bank only needs to sell the house for the value of the loan, not the value of the house, so owner may lose their equity. Ex. Owner bought house for $400K, put down $100k and took a loan for $300K. If he defaults of mortgage payments and bank forecloses then the bank will sell the house to repay the debt. Bank will try to sell for high amount but only needs to sell for $300K and if so then the owner loses their $100K value in the house. Make sure your income can support the mortgage. d. Loan terminology: • principal amount of the loan: the amount you are borrowing • interest rate: a percentage (ex 10%) • interest: the additional amount you pay to borrow the money (the principal multiplied by the interest rate) • term of loan: how long before you need to pay the loan back • maturity date: the date when the loan becomes due • If you're taking a loan, bank will make you add in real estate taxes and insurance into your monthly payments to make sure you pay it. Example: You take a 20-year $1,000 loan at a rate of 10%, due on January 1, 2020. principal amount of the loan: $1,000 interest rate: 10% interest: $100 ($1,000 x 10%) term of loan: 20 years maturity date: January 1, 2020 e. Types of loans: • Fixed vs. adjustable rate: Fixed: same rate throughout the term of the loan (ex 10%) Adjustable: interest rate can change based on loan or economic situation). Fixed is generally safer. • Term vs. Amortized Loan: Term: pay interest only until the end when a balloon payment is due Amortized: pay principal and interest all along so your payments stay the same). Amortized is generally safer. 5. Do a title search a. Title=ownership. You want to make sure the prior owner actually has title to the property and has the right to sell you the property. You can check all the records (the chain of title) or hire a title insurance company to do all the work for you. b. Title company will also check for any liens or judgments against the property 6. Closing (usually happens 60-90 days after the contract is signed) a. The exchange of the deed for the money b. Who attends? Buyer (borrower), buyer's lawyer, seller, seller's lawyer, bank, bank's attorney, title insurance representative c. What other fees are paid at the closing? Real estate broker commission, mortgage broker's fee, fees for recording deed and mortgage, transfer taxes to government, maybe also lawyer's fees E. Additional Real Property Concepts: 1. Adverse Possession: If land has been abandoned and someone else starts using it for a specified period of time, that person can claim adverse possession to the property as its new owner (must be open, continuous, and adverse) 2. Eminent Domain: Property may be taken by the government for public use (not for private benefit) and the owner is paid (ex to build airport) F. Landlord-Tenant Relationships 1. A lease contract arises when a property owner (landlord) agrees to give another party (the tenant) the exclusive right to possess the property for a limited time. Tenant pays rent for this right. Quiet Enjoyment: the landlord promises that during the lease term, neither the landlord nor anyone having a superior title to the property will disturb the tenant's use and enjoyment of the property. 2. In most states, statutes require leases for terms exceeding one year to be in writing. 3. Eviction occurs when the landlord deprives the tenant of possession of the leased property or interferes with the tenant's use or enjoyment of it (ex. landlord changes locks). Constructive eviction occurs when the landlord fails to perform duties under the lease, making the tenant's use of premises difficult or impossible (ex no heat or severe rat infestation so tenant leaves). 4. Maintenance of the Premises: The tenant is responsible for any damage to the premises that he or she causes, intentionally or negligently. The landlord can hold the tenant liable for the cost of fixing damage. Landlord is responsible for maintaining common areas such as stairs and must also ensure that the premises are safe, habitable and in good repair. 5. Assignment: The tenant's transfer of his or her entire interest in the leased property to a third person. Most assignments require a landlord's consent. An assignment does not release the original tenant (assignor) from the obligation to pay rent if the assignee defaults. Sublease: The tenant's transfer of all or part of the premises for a period shorter than the lease term. Similar to an assignment, a sublease requires a landlord's consent and does not release the original tenant (assignor) from the obligation to pay rent if the assignee defaults. ​Below are some links to standard types of leases and contracts of sale. These are for educational purposes only and you should always consult with a lawyer before signing any legal document. Sample standard residential lease from Legal Templates.net Sample standard commercial lease from Legal Templates.net Sample Contract of Sale of Residential Real Property from the NYS Bar Association

Chapter 7 Corporation formation and finance

What is a "C" corporation A. A legal entity created and recognized by state law a legal entity. 1. Can have one or more shareholders comprised of natural persons or businesses. Shareholders can sue the corporation and be sued by the corporation and bring a derivative suit on behalf of the corporation. 2. Enjoys same rights as natural person: can sue, be sued, own property. 3. Management: by a Board of Directors (elected by shareholders) who make policy decisions and hire officers to run day-to-day business 4. Liability: Generally, shareholders are not personally liable for corporate acts, but in certain situations, the corporate "veil" of limited liability can be pierced, holding the shareholders personally liable. 5. Profits: can either be kept as retained earnings or passed on to the shareholders as dividends 6. Taxation: Can be taxed twice, first to corporation, then to shareholders via dividends. 7. Criminal Acts: A corporation can be liable for the criminal acts of its agents and employees. Corporations can be fined and, under the "responsible officer" doctrine, corporate officers may go to prison. 8. Tort Liability: Under respondeat superior, corporations are also liable for torts committed by agents within the scope of their employment. B. How do we classify corporations? 1. Based on where incorporated: Domestic: Corporation does business within its state of incorporation. Foreign: Corporation in X state does business in Z state. Alien: Corporation formed in another country. 2. Based on government or private: Public: are formed by the government for some purpose (e.g., U.S. Postal Service). Private: are created either wholly or in part for private benefit (for profit). 3. Based on what they do with their profit: For-profit: to give profit back to shareholders (most typical) Nonprofit (not-for-profit): Those formed for purposes other than making a profit for shareholders (e.g., private hospitals and charities). 4. Based on who can own shares: Close/privately held: shares are held by relatively few persons and is often operated like a partnership. Management resembles that of a sole proprietorship or a partnership. a close corporation can restrict the transferability of shares via the shareholder agreement. A majority shareholder in a close corporation may misappropriate company funds. Publicly traded/open: ownership is dispersed among the general public in many shares of stock which are freely traded on a stock exchange or in over the counter markets. C. What are some unique types of corporations? 1. "S" corporation: Avoids federal "double taxation" of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. Must have no more than 100 shareholders. 2. Professional corporation: Those formed by a group of professionals (such as lawyers). Laws governing the formation and operation of professional corporations are similar to those governing ordinary business corporations. 3. "B" or Benefit Corporations: A for-profit corporation that seeks to have a material positive impact on society, but must comply with certain statutory requirements. They differ from traditional corporations in the following areas: purpose, accountability, and transparency. D. How are corporations formed? 1. Promotors uses subscription agreements to attractive potential investors. Promoters are liable for pre-incorporation contracts, unless third party agrees to hold the future corp. liable. 2. Must choose state of incorporation, name (make sure no doubles or deception) 3. Prepare articles of incorporation and file with the secretary of state (name, number of shares authorized to issue, registered agent and incorporators with addresses). Corp is then "chartered". 4. Shareholders have first organizational meeting to approve by-laws, elect directors, hire officers and ratify pre-incorporation contracts. 5. Improper formation: how? a. De Jure: A corporation that has substantially complied with all conditions needed for incorporation but something not substantial was wrong or missing from the filing. In most states, filing of articles is conclusive proof of incorporation (it's a good corporation) b. De Facto: If the defect in formation is substantial, states differ. Some say it's a de facto corp and courts will treat it like a corp if certain conditions met c. by Estoppel: If it acts like a corporation, it cannot avoid liability by claiming that no corporation exists because it didn't file articles of incorporation. This applies with contracts made with third parties. E. Corporate Powers 1. Express Powers: stated explicitly in the articles of incorporation, state laws or statutes 2. Implied Powers: power to perform all acts reasonably necessary to accomplish corporate purposes. Corporate officer can bind the corporation (remember agency law) 3. Ultra Vires Powers: corporate acts beyond the express or implied powers of the corporation. Solution: most articles of incorporation adopt very broad powers to avoid this problem. F. Piercing the Corporate Veil 1. Definition: courts will hold shareholders personally liable for debts/acts of the corporations in the interests of justice and fairness. 2. When will court do this? a. A third party tricked into dealing with a corporation rather than the individual. b. Corporation is set up never to make a profit, to always be insolvent, or is undercapitalized. c. Corporation is formed to evade an existing legal obligation. d. Statutory formalities are not followed. e. There is commingling of personal and corporate interests or assets. 3. Piercing the veil is a Potential Problem for Close Corporations: -Separate status must be preserved. -Commingling of funds. -No director meetings. -Shareholder use of corporate property. 4. The Alter-Ego Theory: The corporation is "alter ego" of majority shareholder, and personal and corporate interest are commingled such that the corporation has no separate identity. Courts use to avoid injustice or fraud that would result when wrongdoers are protected by limited liability. G. How are corporations financed? 1. Most often through issuance of corporate securities: a. Stocks: (equity securities): The purchase of ownership in the business firm. Stocks provide pro-rata (proportional) ownership interest reflected in voting, control, earnings, and assets. 1) Common stock: has voting rights, gets paid dividends from profit based on proportion of shares 2) Preferred stock: no voting rights but usually have priority over holders of common stock as to dividends and payment on dissolution of the corporation. b. Bonds: (debt securities): The borrowing of funds by firms (and governments). Bonds have a maturity date—when principal is returned to investor. 2. Venture Capital: Start-up businesses and high-risk enterprises need start-up and expansion capital. The start-up typically gives a share of its stock to the venture capitalists that provided funding. 3. Private Equity Capital: Obtain capital from wealthy investors. Ultimately, the company may sell shares in an IPO. 4. Crowdfunding: A cooperative activity in which people network and pool funds/other resources via the Internet to fund a cause or a venture. New Securities and Exchange Commission (SEC) rules allow companies to sell securities through crowdfunding but they are limited to raising $1 million this way and are required to make specific disclosures.