BLAW 308 ch 42: Organization and Financial Structure of Corporations

Buy-sell agreement

- Compels a s/h to sell to the corp. at a pre-determined price - Obligates them to purchase the shares

Steps to Incorporate

1) Prepare Articles of Incorp. 2) 1 or more incorporators must sign Articles 3) File Articles w. VA State Corporation Commission & pay filing fee 4) Receive a Certificate of Incorp. from SCC (Shareholders must approve most changes in the articles as the articles are a contract between shareholders and the corporation) 5) Hold organizational meeting for purpose of adopting bylaws & pre-incorp. C's, also elect officers.

4 Types of Restrictions

1) Rights of first refusal and option agreements 2) Buy-sell agreements 3) Consent restraints 4) Provisions disqualifying purchasers

preincorporation share subcriptions

1. A prospective shareholder offers to buy a specific number of shares at a stated price 2. Ensure that the corporation will have enough capital 3. MBCA does not allow the prospective shareholder to revoke for a 6-month period 4. Promoters have no liability in the absence of fraud or other wrongdoing, but they have a duty to make a good faith effort to bring the corporation into existence

transfer of shares occurs through

1. Either a. Indorsement of share certificate on it back by its registered owner; and b. The delivery of the certificate to another person 2. Or (street certificate) a. Delivery of share certificate b. Without indorsement

liability of crop to promoter

1. Generally, no compensation for promotional services or expenses is required 2. MBCA permits shares to be issued for a promoter's preincorporation services

obtaining a binding preincorporation contract

1. In order for the third party to be liable, the promoter must be liable 2. Once the corporation adopts the contract, both the corporation and third party are liable and cannot rescind without consent 3. Automatic novation clause: wording in a contract to indicate the promoter's liability ceases upon adoption by the corporation

Promoter's Liability on Preincorporation Contracts

1. Jointly and severally liable with copromoters, including the torts committed prior to incorporation 2. Liability exists even if the promoter's name is not on the contract 3. Novation must occur to remove liability

liability for defective incorporation

1. Persons are generally deemed to be partners with unlimited liability for contracts and torts of the business 2. Most courts only impose contractual liability on those who are a. Actively engaged in the management of the business; or b. Responsible for the defects in organization 3. Tort liability is generally imposed on everyone, managers and purported shareholders alike

relation of promoter and prospective corp

1. Promoter is not an agent 2. Promoter does owe fiduciary duties: full disclosure and honesty a. Cannot divert money from prospective shareholders to pay own expenses b. Cannot divert a business opportunity from the corporation and give to him or herself c. May not purchase shares at a price lower than that paid by public shareholders d. May not profit personally via secret transactions

Uniform Commercial Code (UCC) Article 8

1. Regulates the issuance of securities 2. Permits a corporation to only issue the number of shares authorized by its articles 3. Overissued shares are void a. Two remedies for someone entitled to overissued shares i. Corporation must obtain identical shares and deliver them to the person; or ii. Corporation must reimburse the person for the value paid for the shares plus interest b. Directors may incur liability, including criminal

quality of consideration for shares

1. Statutes require legal consideration to have real value 2. MBCA permits share to be issued in return for tangible or intangible property or benefit, including a. Cash b. Promissory notes c. Services d. Contracts for services e. Securities 3. MBCA allows corporations to issue shares to their promoters in consideration fo

Model Business Corporation Act (MBCA)

A model state law dealing with corporations, drafted by an organization of business lawyers, which has been enacted by many states.

share subscriptions

A. A prospective shareholder promises to buy a specific number of shares at a stated price B. Subscriber is a shareholder, even if the shares have not been issued C. MBCA: subscriptions do not have to be in writing to be enforceable D. Postincoporation subscriptions bind the corporation and subscriber E. When the Board demands payment from subscribers, it must demand from all subscribers of a class of shares or none of them: no discrimination

Articles of Incorporation

Basic governing document Must state: •The name of the corp. •# of shares authorized •Address of the initial registered office & name of the registered agent

par-value shares

Fixed face value noted on stock certificate arbitrary dollar amount assigned to shares by articles of incorporation a. Does not reflect the fair market value b. Minimum amount of consideration for which the shares may be issued c. Discount shares i. Issued for less than par value ii. Board of directors is liable to corporation for issuance

Financing For-Profit Corporations

For-Profit are financed by: • Sale of securities • Bank loans • Short-term financing

De Jure Corporation

Formed when promoters substantially comply with each of the mandatory conditions for incorporation b. Treated like a corporation for all purposes c. Can only be attacked in a quo warranto proceeding: state asserts noncompliance with a condition subsequent to incorporation, like failure to file an annual report

Right of first refusal

Grants a right to match the offer that a selling s/h receives

Option agreement

Grants an option to buy a selling s/h shares at a predetermined price

restrictions against transfering shares

Historically, shareholders are free to sell shares to whomever they want whenever they want In close corporations, free transferability threatens the balance of power among shareholders Modern corporation statutes permit most transfer restrictions, especially for close corporations

Bonds

Long-term, secured security

Debentures

Long-term, unsecured securities, 10-30 yr term

close corporation elections

Most statutes require a corporation make an election to be treated like a close corporation 2. Statutory Close Corporation Supplement to the MBCA allows a corporation with less than 50 shareholders to elect to be a close corporation 3. No penalty for a failure to make election 4. Courts may apply common law rules applicable to close corporations even in the absence of statutory election

Annual Report

Must file to retain corporate status

Corporation's Liability on Preincorporation Contracts

No liability on contracts made by a promoter prior to incorporation a. Not automatically liable after becoming a corporation b. Must adopt promoter's preincorporation contract in order to become liable i. Must accept the contract with knowledge of all its material facts ii. May be express or implied

Are corporations liable on pre-incorporation contracts's that the promoter enters into on behalf of the non-existent corporation?

No, unless adoption occurs.

Warrants

Options evidenced by certificates

warrants

Options evidenced by certificates

Consent restraints

Requires selling s/h to obtain the consent of the corp/ before they may sell their shares

enforceability of transfering shares

Restriction must be contained in the articles of incorporation, bylaws, an agreement among shareholders, or an agreement between the corporation and shareholders; and b. Shareholder must agree to restriction or purchase the shares with notice c. Stufft v. Stufft: since no agreements to sell the stock were reached, the transfer restriction was not initiated

Rights

Short-term warrants that are usually transferrable

Bylaws

State the powers, rights & responsibilities of the corporation, directors & shareholders

Notes

Term of less than 5 yrs

Novation

The corporation and the 3rd party agree to release the promoter from liability.

to transfer shares

UCC requires corporation to register the transfer of any registered shares if properly indorsed Bona fide purchaser: 1. Buys shares in good faith 2. With no notice of any adverse claim against the shares Corporation must register the transfer to a bona fide purchaser unless overissuance would result

Provisions Disqualifying Purchasers

Used to exclude unwanted persons from becoming s/h

Adoption

When the corporation accepts the contract w/ full knowledge of all its material facts

Is a promoter personally liable on pre-inc. C's that the promoter enters into on behalf of the non-existent corp?

Yes, until a novation occurs.

defective corporation

a corporation about which an error or omission was made during its incorporation process corporation by estoppel de facto de jure

how does novation occur to remove liability from promoter?

a. Corporation and third party agree to release the promoter from liability; and b. To substitute the corporation for the promoter as the party liable on the contract c. Can be express or implied agreement

Corporation by Estoppel

a. Court will not deny the existence of a corporation when i. People hold themselves out as representing a corporation; or ii. Believe themselves to be dealing with a corporation b. Each contract must be considered individually to determine if either party is prevented from denying the corporation's existence

de facto corporation

a. Formed when incorporators fail in a material respect to comply with all of the mandatory provisions of the incorporation statute, yet comply with most b. 3 requirements i. Valid statute exists under which the corporation could be organized ii. Promoters make an honest attempt to organize under statute iii. Promoters or managers exercise corporate powers c. Treated as a corporation with respect to i. An attack by a third party ii. An attempt by the business itself to deny that it is a corporation d. State may attack in a quo warranto proceeding

debt securities - debentures or long-term bonds

a. Long-term b. Unsecured c. Typically have a term of 10 to 30 years d. Usually have indentures: contract that states the rights of debenture holders

legality of restriction of transfering shares

a. MBCA: authorizes for any reasonable purpose, judged in light of the character and needs of the corporation b. Consent restraints and provisions disqualifying purchases are permissible if they are not manifestly unreasonable c. Per se reasonable i. Any consent restraint that maintains a corporation's status when the status is dependent on the number or identity of shareholders ii. Any restriction that preserves registration exemptions under the Securities Act of 1933 and state securities laws

types of restrictions

a. Right of first refusal: grants the corporation or other shareholders the right to match the offer that a selling shareholder receives b. Option agreement: grants the corporation or other shareholders an option to buy the selling shareholder's shares at a price to be determined by agreement c. Buy-and-sell agreement: requires a shareholder to sell his shares to the corporation or to other shareholders at the price stated in the agreement d. Consent restraint: requires a selling shareholder to obtain the consent of the corporation or other shareholders before he or she may sell e. Provision disqualifying purchasers: excludes unwanted persons from the corporation

options

contracts that give investors the choice to buy or sell stock and other financial assets MBCA allows the board of directors to issue options for the purchase of a corporation's shares

MBCA for issuance of shares

does not require a corporation to issue share certificates; a written statement with the information required in the certificate suffices

financing for-profit corporations

equity securities (stock, shares) Creates an ownership relationship: stockholders or shareholders are owners of the corporation common shares, preferred shares authorized, issues, and outstanding shares options, warrants rights, debt securities

oustanding shares

hares currently held by shareholders

preferred shares

i. Have preferences over other classes of shares ii. Shareholders are customarily given liquidation and dividend preferences over common shareholders iii. MBCA: preferences must be set out in the articles of incorporation a) Liquidated preferences: a stated dollar amount that must be distributed b) Dividend preferences: can be cumulative or noncumulative c) Participating preferred shares: have priority up to a stated amount or percentage of the dividends to be paid d) Mandatory dividend: generally held to be illegal e) Redemption: allows a corporation to repurchase shares at its option, despite shareholders' unwillingness iv. May be convertible into another class of shares v. Have voting rights, unless articles state differently

common shares

i. Often occupy a position inferior to that of other classes ii. Shareholders have the exclusive right to elect the directors, who manage the corporation iii. Have an exclusive claim to the corporate earnings and assets that exceed the claims of creditors and other shareholders

quantity of consideration for shares

par value fair value 3. Accounting for Consideration Received a. Stated capital account: the number of shares outstanding multiplied by the par value of each share b. Capital surplus: excess or surplus consideration received when shares are sold for more than par value c. MBCA has eliminated the terms stated capital and capital surplus 4. Resales of Shares a. Board may sell treasury sales for less than par value, if it sells them for an amount equal to their fair value b. A shareholder may buy shares from another shareholder for less than par value or fair value and no liability results

preemptive right

requires a corporation to offer each existing shareholder the opportunity to buy newly issued shares in the same proportion as shareholder's current ownership

Fair value of a share

shares are often worth more than their par value a. Board's judgment as to the amount of consideration received for shares is conclusive when it i. Acts in good faith ii. Exercises the care of ordinarily prudent directors; and iii. Acts in the best interests of the corporation b. Board's valuation of consideration is also conclusive when it i. Acts in good faith ii. Exercises the care of ordinarily prudent directors; and iii. Acts in the best interests of the corporation c. Watered shares i. Board impermissibly overvalues the consideration for shares ii. Both board and shareholders are liable to the corporation d. Fully paid and nonassessable: shareholder has paid proper amount of consideration

authorized shares

shares that a corporation is permitted to issue pursuant to its articles of incorporation

issued shares

shares that have been sold to shareholders

Types of Shares

• Authorized Shares- the # permitted to issue • Issued Shares- # that have been sold to s/h • Oustanding Shares- # currently held by s/h

Pre-incorporation Share Subscriptions (PSS)

• C's which a prospective shareholder offers to buy a specific # of shares in a new corporation @ a stated price • May not revoke offer for up to 6 months

Equity Securities

• Creates ownership • Shareholders own a corp. • Common & Preferred Stock

Transfer of Shares

• Endorsement & Delivery of a certificate • Shares in publicly held corps are freely transferrable

Common Shareholders

• Exclusive right to elect directors • Lowest ranking shareholder • Claims to corporate earnings

Defective Incorporation

• Failure to comply with all conditions • Shareholders/officers could be personally liable

De Facto Corporation

• Failure to comply with some mandatory requirements

Promoter Duties

• Fiduciary Duty • Corporation not required to compensate • Promoter is not an agent

The MBCA

• Filing of Articles is conclusive proof that the corporation exists

Options

• Give the holder the right to purchase a # of shares at a stated price • Non-transferrable

Corporation by Estoppel

• Managers & Shareholders are held w/ unlimited liability

Non-Profit Incorporation

• Public Benefit Corp. • Mutual Benefit Corp. • Religious Corp. • Articles must state if it will have members

Preferred Shareholders

• Several classes • Preference in regard to assets or dividends

Promoter

• Someone who incorporates a business • Organizes initial management • Raises initial capital for a corporation

De Jure Corporation

• Substantially complied with all mandatory requirements

When does the MBCA impose joint liability on managers/shareholders?

• When they participate in operational decisions AND, know the corp. doesn't exist