Chapter 18

Ultra vires doctorine

"beyond the power." In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts.

Brodie, Jordan, and Barbara form a close corporation to operate a machine shop. Brodie and Jordan own 75 percent of the shares in the company, but all three are directors. After disagreements arise, Brodie asks the company to purchase his shares, but his requests are refused. A few years later, Brodie dies, and his wife, Ella, inherits his shares. Jordan and Barbara refuse to perform a valuation of the company, deny Ella access to corporate information, do not declare any dividends, and refuse to elect Ella as a director. In this situation, the majority shareholders have violated their fiduciary duty to Ella.

. A common example of a breach of fiduciary duty occurs when the majority shareholders "freeze out" the minority shareholders and exclude them from certain benefits of participating in the firm.

The following are some of the factors that frequently cause the courts to pierce the corporate veil:

1. A party is tricked or misled into dealing with the corporation rather than the individual. 2. The corporation is set up never to make a profit or always to be insolvent. Alternatively, it is too thinly capitalized—that is, it has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities. 3. The corporation is formed to evade an existing legal obligation. Statutory corporate formalities, such as holding required corporation meetings, are not followed. 5. Personal and corporate interests are mixed together, or commingled, to such an extent that the corporation has no separate identity.

In those states, the courts will treat a corporation as a legal corporation despite a defect in its formation if the following three requirements are met:

1. A state statute exists under which the corporation can be validly incorporated. 2. The parties have made a good faith attempt to comply with the statute. 3. The parties have already undertaken to do business as a corporation.

certificate of authority

A corporation does not have an automatic right to do business in a state other than its state of incorporation. In some instances, it must obtain a certificate of authority in any state in which it plans to do business.

Alien Corporation

A corporation formed in another country (say, Mexico) but doing business in the United States is referred to in the United States as an alien corporation.

foreign corporation

A corporation formed in one state but doing business in another is referred to in the second

Tort liability

A corporation is liable for the torts committed by its agents (including most employees who deal with third parties) or officers within the course and scope of their employment.

inside director

A director who is also an officer of the corporation is referred to as an inside director

Voting trust

A voting trust is an agreement (a trust contract) under which a shareholder assigns the right to vote his or her shares to a trustee, usually for a specified period of time

Duty of care for a director

Act in good faith (honestly). Exercise the care that an ordinarily prudent (careful) person would exercise in similar circumstances. Do what she or he believes is in the best interests of the corporation [RMBCA 8.30(a), 8.42(a)].

Corporate financing

Corporations normally are financed by the issuance and sale of corporate securities. Securities—stocks and bonds—evidence an ownership interest in a corporation or a promise of repayment of debt by a corporation. Some corporations may also seek alternative financing through venture capital, private equity capital, and crowdfunding.

Crowdunding

Crowdfunding is a cooperative activity in which people network and pool funds and other resources via the Internet to assist a cause or invest in a venture.

de facto corporation

If the defect in formation is substantial, such as a corporation's failure to hold an organizational meeting to adopt bylaws, the outcome will vary depending on the jurisdiction. Some states, including Mississippi, New York, Ohio, and Oklahoma, recognize the common law doctrine of de facto corporation.

board of directors

In a corporation, the responsibility for the overall management of the firm is entrusted to a board of directors, whose members are elected by the shareholders.

Taxes and holding companies explained

In general, any profits received by the holding company on these investments are taxed at the rate of the offshore jurisdiction where the company is registered. Once the profits are brought "onshore," though, they are taxed at the federal corporate income tax rate. Any payments received by the shareholders are also taxable at the full U.S. rates.

Private equity capital

Private equity firms pool funds from wealthy investors and use this private equity capital to invest in existing corporations. Usually, a private equity firm buys an entire corporation and then reorganizes it. Sometimes, divisions of the purchased company are sold off to pay down debt.

Non profit corporations

Private hospitals, educational institutions, charities, and religious organizations, for instance, are frequently organized as nonprofit corporations. The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without exposing the individual members to personal liability.

Professional corporations

Professionals such as physicians, lawyers, dentists, and accountants can incorporate. A professional corporation typically is identified by the letters P.C. (professional corporation), S.C. (service corporation), or P.A. (professional association).

Rights of shareholders

Shareholders in a corporation enjoy both common law and statutory inspection rights. The RMBCA provides that every shareholder is entitled to examine specified corporate records, including voting lists

Accountability of benefit corporation

Shareholders of a benefit corporation determine whether the company has achieved a material positive impact. Shareholders also have a right of private action, called a benefit enforcement proceeding, enabling them to sue the corporation if it fails to pursue or create public benefit.

The following order of priority is used if a conflict arises among the various documents involving a corporation:

The U.S. Constitution. State constitutions. State statutes. The articles of incorporation. Bylaws. Resolutions of the board of directors.

Mark Bloom was an officer and a director of MB Investment Partners, Inc. (MB), at the time that he formed North Hills, LP, a stock investment fund. Bloom and other MB employees used MB's offices and equipment to administer investments in North Hills. Later, investors in North Hills requested a full redemption of their investments. By that time, however, most of the funds that had been invested were gone. North Hills had, in fact, been a Ponzi scheme that Bloom had used to finance his lavish personal lifestyle, taking at least $20 million from North Hills for his personal use. Barry Belmont and other North Hills investors filed a suit in a federal district court against MB, alleging fraud. The court held that MB was liable for Bloom's fraud. MB appealed, and the appellate court affirmed.....

Tort liability can be attributed to a corporation for the acts of its agent that were committed within the scope of the agent's employment.

Public Corporation

a corporation formed by the government to meet some political or governmental purpose. Cities and towns that incorporate are common examples. In addition, many federal government organizations, such as the U.S. Postal Service, the Tennessee Valley Authority, and AMTRAK, are public corporations.

Business judgement rule

corporate director or officer will not be liable to the corporation or to its shareholders for honest mistakes of judgment and bad business decisions.

corporate taxation

corporate profits can be subject to double taxation. The company pays tax on its profits

Private corporations

created either wholly or in part for private benefit—that is, for profit. Most corporations are private. Although they may serve a public purpose, as a public electric or gas utility does, they are owned by private persons rather than by a government.

Stock certificates

evidenced ownership of a specified number of shares in the corporation

Benefit corporation

for-profit corporation that seeks to have a material positive impact on society and the environment. Benefit corporations differ from traditional corporations in the following ways:

Holding Company

is a company whose business activity consists of holding shares in another company. Typically, the holding company is established in a low-tax or no-tax offshore jurisdiction, such as the Cayman Islands, Dubai, Hong Kong, Luxembourg, Monaco, or Panama.

Corporation

legal entity created and recognized by state law - recognized as a person (an artificial legal person)

quorum

minimum number of members of a body of officials or other group who must be present for business to be validly transacted.

Katlin is a shareholder who owns 10 percent of a company. Because she also has preemptive rights, she can buy 10 percent of any new issue (to maintain her 10 percent position). Thus, if the corporation issues 1,000 more shares, Katlin can buy 100 of the new shares.

preemptive rights,

right to indemnification

reimbursement) for the legal costs, fees, and damages incurred.

Corporate officers

run the daily business operations

preemptive rights,

shareholder receives a preference over all other purchasers to subscribe to or purchase a prorated share of a new issue of stock. Generally, preemptive rights must be exercised within a specific time period (usually thirty days).

Directors

sometimes inappropriately characterized as agents because they act on behalf of the corporation. No individual director, however, can act as an agent to bind the corporation.

Implied powers

the corporation has the implied power to perform all acts reasonably necessary to accomplish its corporate purposes. For this reason, a corporation has the implied power to borrow and lend funds within certain limits and to extend credit to parties with whom it has contracts.

outside director.

whereas a director who does not hold a management position is an outside director

right of inspection

which means that each director can access the corporation's books and records, facilities, and premises.

Different laws for close corporations

The statutes in many states allow close corporations to depart significantly from certain formalities required by traditional corporation law. Under the RMBCA, close corporations have considerable flexibility in determining their operating rules [RMBCA 7.32]. If all of a corporation's shareholders agree in writing, the corporation can operate without directors and bylaws. In addition, the corporation can operate without annual or special shareholders' or directors' meetings, stock certificates, or formal records of shareholders' or directors' decisions.

Majority shareholders fiduciary duty

This duty arises when a single shareholder (or a few shareholders acting in concert) owns a sufficient number of shares to exercise de facto control over the corporation. In these situations, the majority shareholder owes a fiduciary duty to the minority shareholders.

Three siblings, Sherry, Karen, and Henry Johnson, are the only shareholders of Johnson's Car Wash, Inc. Henry wants to sell his shares, but Sherry and Karen do not want him to sell the shares to a third person unknown to them.

To avoid this situation, a close corporation can restrict the transferability of shares to outside persons. Shareholders can be required to offer their shares to the corporation or to the other shareholders before selling them to an outside purchaser. In fact, in a few states close corporations must transfer shares in this manner under state statutes.

The business judgment rule will apply as long as the director or officer:

Took reasonable steps to become informed about the matter. Had a rational basis for her or his decision. Did not have a conflict between her or his personal interest and the interest of the corporation.

Requirments for S corporation

1. The corporation must be a domestic corporation. 2. The corporation must not be a member of an affiliated group of corporations. 3. The shareholders must be individuals, estates, or certain trusts and tax-exempt organizations. Partnerships and nonqualifying trusts cannot be shareholders. Corporations can be shareholders under certain circumstances. 4. The corporation must have no more than one hundred shareholders. 5. The corporation must have only one class of stock, although it is not necessary that all shareholders have the same voting rights. 6. No shareholder of the corporation may be a nonresident alien.

Incorporation procedures

1. select the state of encorporation 2. secure an appropriate corporate name 3. prepare articles of encorporation 4. file the articles with the state

Transparency of benefit corporation

A benefit corporation must issue an annual benefit report on its overall social and environmental performance that uses a recognized third-party standard to assess its performance. The report must be delivered to the shareholders and posted on a public website.

publicly held corporation

A publicly held corporation (often called a public company) is any corporation whose shares are publicly traded in a securities market, such as the New York Stock Exchange or the NASDAQ.

Purpose of benefit corporation

Although a benefit corporation is designed to make a profit, its purpose is to benefit the public as a whole. (In contrast, the purpose of an ordinary business corporation is to provide long-term shareholder value.) The directors of a benefit corporation must, during the decision-making process, consider the impact of their decisions on society and the environment.

Bonds

Bonds are debt securities, which represent the borrowing of funds. Bonds are issued by business firms and by governments at all levels as evidence of funds they are borrowing from investors.

Transfer of shares in close corporations

By definition, a close corporation has a small number of shareholders. Thus, the transfer of one shareholder's shares to someone else can cause serious management problems. The other shareholders may find themselves required to share control with someone they do not know or like.

pierce the corporate veil

Certain situations impose liability on shareholders for the corporation's obligations.

Preemtive rights are most important in....

Close coorpoerations

Directors are also expected to exercise a reasonable amount of supervision when they delegate work to corporate officers and employees.

Dana, a corporate bank director, fails to attend any board of directors' meetings for five years. In addition, Dana never inspects any of the corporate books or records and generally fails to supervise the activities of the bank president and the loan committee. Meanwhile, Fulton, the bank president, who is a corporate officer, makes various improper loans and permits large overdrafts. In this situation, Dana (the corporate director) can be held liable to the corporation for losses resulting from the unsupervised actions of the bank president and the loan committee.

Illegal dividends

Dividends are illegal if they are improperly paid from an unauthorized account or if their payment causes the corporation to become insolvent (unable to pay its debts as they come due). Generally, shareholders must return illegal dividends only if they knew that the dividends were illegal when the payment was received (or if the dividends were paid when the corporation was insolvent). Whenever dividends are illegal or improper, the board of directors can be held personally liable for the amount of the payment.

case

Dog House Investments, LLC, operated a dog "camp" in Nashville, Tennessee. Dog House leased the property from Teal Properties, Inc., which was owned by Jerry Teal, its sole shareholder. Under the lease, the landlord promised to repair damage that rendered the property "untenantable" (unusable). Following a flood, Dog House notified Jerry that the property was untenantable. Jerry assured Dog House that the flood damage was covered by insurance but took no steps to restore the property. The parties then agreed that Dog House would undertake the repairs and be reimbursed by Teal Properties. Dog House spent $39,000 to repair the damage and submitted invoices for reimbursement. Teal Properties recovered $40,000 from its insurance company but did not pay Dog House. Close to bankruptcy, Dog House sued Teal Properties and Jerry. The court pierced the corporate veil and held Jerry personally liable for the repair costs. An appellate court affirmed. Teal Properties owned no property and had no assets. It received rent but paid it immediately to Jerry. The court concluded that the company was not operated as an entity separate from its sole shareholder

Nevertheless, cases involving ultra vires acts are sometimes brought against nonprofit corporations or municipal (public) corporations.

Four men formed a nonprofit corporation to create the Armenian Genocide Museum & Memorial (AGM&M). The bylaws appointed them as trustees (similar to corporate directors) for life. One of the trustees, Gerard Cafesjian, became the chair and president of AGM&M. Eventually, the relationship among the trustees deteriorated, and Cafesjian resigned. The corporation then brought a suit claiming that Cafesjian had engaged in numerous ultra vires acts, self-dealing, and mismanagement. Although the bylaws required an 80 percent affirmative vote of the trustees to take action, Cafesjian had taken many actions without the board's approval. He had also entered into contracts for real estate transactions in which he had a personal interest. Because Cafesjian had taken actions that exceeded his authority and had failed to follow rules set forth in the bylaws, the court ruled that the corporation could go forward with its suit.

quorum

Generally, a quorum exists when shareholders holding more than 50 percent of the outstanding shares are present.

piercing the corporate veil

Generally, courts pierce the veil when the corporate privilege is abused for personal benefit or when the corporate business is treated so carelessly that it is indistinguishable from that of a controlling shareholder.

S corporation

If a corporation has S corporation status, it can avoid the imposition of income taxes at the corporate level while retaining many of the advantages of a corporation, particularly limited liability.

De jure corporations

If a corporation has substantially complied with all conditions precedent to incorporation, the corporation is said to have de jure (rightful and lawful) existence. In most states and under RMBCA 2.03(b), the secretary of state's filing of the articles of incorporation is conclusive proof that all mandatory statutory provisions have been met

Carlia Cichon is president of Advent Home Medical, Inc. Her daughter, Amanda Hammoud, owned 400 shares (40 percent) of Advent stock. Hammoud submitted a written request to Cichon to review Advent's financial records "to monitor the financial health of the corporation." When Advent did not respond, Hammoud filed a complaint in a state court seeking an order to compel the corporation to permit an inspection. The court granted Hammoud's motion to compel the inspection. Advent appealed. A Michigan state appellate court affirmed. Hammoud was a shareholder and had stated a proper purpose for inspecting the records she requested

Inspection rights

Managements of close corporations

Management of a close corporation resembles that of a sole proprietorship or a partnership, in that control is held by a single shareholder or a tightly knit group of shareholders. As a corporation, however, the firm must meet all specific legal requirements set forth in state statutes. To prevent a majority shareholder from dominating the company, a close corporation may require that more than a simple majority of the directors approve any action taken by the board

Close corporations

Most corporate enterprises in the United States fall into the category of close corporations. A close corporation is one whose shares are held by relatively few persons, often members of a family. Close corporations are also referred to as closely held, family, or privately held corporations. Because the number of shareholders is so small, there is no trading market for the shares. In practice, a close corporation is often operated like a partnership.

limited liability

One of the key advantages of the corporate form is the limited liability of its owners. Normally, corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments.

shareholder agreement.

One way the close corporation can effect restrictions on transferability is by spelling them out in a shareholder agreement. A shareholder agreement can also provide for proportional control when one of the original shareholders dies. The decedent's shares of stock in the corporation can be divided in such a way that the proportionate holdings of the survivors, and thus their proportionate control, will be maintained.

A Potential Problem for Close Corporations

Pip, Jimmy, and Theodore Brennan are brothers and shareholders of Brennan's, Inc., which owns and operates New Orleans's famous Brennan's Restaurant. As a close corporation, Brennan's, Inc., did not hold formal corporate meetings with agendas and minutes, but it did maintain corporate books, hold corporate bank accounts, and file corporate tax returns. The Brennan brothers retained attorney Edward Colbert to represent them in a family matter, and the attorney's bills were sent to the restaurant and paid from the corporate account. Later, when Brennan's, Inc., sued Colbert for malpractice, Colbert argued that the court should pierce the corporate veil because the Brennan brothers did not observe corporate formalities. The court refused to do so, however, because there was no evidence of fraud, malfeasance, or other wrongdoing by the Brennan brothers. There is no requirement for small, close corporations to operate with the formality usually expected of larger corporations.

Corporation by Estoppel

Sometimes, a business association holds itself out to others as being a corporation when it has made no attempt to incorporate. In those situations, the firm normally will be estopped (prevented) from denying corporate status in a lawsuit by a third party. The estoppel doctrine most commonly applies when a third party contracts with an entity that claims to be a corporation but has not filed articles of incorporation. It may also apply when a third party contracts with a person claiming to be an agent of a corporation that does not in fact exist.

The Alter-Ego Theory case

Steiner Electric Company (Steiner) is an Illinois corporation that sells electrical products. Steiner sold goods to Delta Equipment Company and Sackett Systems, Inc., on credit. Both Delta and Sackett were owned and controlled by a single shareholder—Leonard Maniscalco. Steiner was not fully paid for the products it sold on credit to Delta and Sackett. Eventually, Steiner sued Delta and won a default judgment, but by that time, Delta had been dissolved. Steiner then asked a state court to pierce the corporate veil and hold Maniscalco liable for the debts of the two companies, claiming the companies were merely Maniscalco's alter egos. The court agreed and held Maniscalco liable. Delta and Sackett were inadequately capitalized, transactions were not properly documented, funds were commingled, and corporate formalities were not observed. Maniscalco had consistently treated both companies in such a manner that they were, in practice, his alter egos

Stock warrents

Stock warrants are rights given by a company to buy stock at a stated price by a specified date. Usually, when preemptive rights exist and a corporation is issuing additional shares, it gives its shareholders stock warrants. Warrants are often publicly traded on securities exchanges.

Stocks

Stocks, or equity securities, represent the purchase of ownership in the business firm. The true ownership of a corporation is represented by common stock. Common stock provides an interest in the corporation with regard to control, earnings, and net assets.

The Alter-Ego Theory

The alter-ego theory is applied when a corporation is so dominated and controlled by an individual (or group) that the separate identities of the person (or group) and the corporation are no longer distinct

corporate taxation is that corporate profits can be subject to double taxation.

The company pays tax on its profits. Then, if the profits are passed on to the shareholders as dividends, the shareholders must also pay income tax on them. (This is true unless the dividends represent distributions of capital, which are returns of holders' investments in the stock of the company.)

NavLink, Inc., a Delaware corporation, provides high-end data management for customers and governments in Saudi Arabia, Qatar, Lebanon, and the United Arab Emirates. NavLink's co-founders, George Chammas and Laurent Delifer, served on its board of directors. Chammas and Delifer were concerned about the company's 2015 annual budget and three-year operating plan. Despite repeated requests, Chammas was never given the meeting minutes from several board meetings in 2015. Chammas and Delifer believed that the other directors were withholding information and holding secret "pre-board meetings" at which plans and decisions were being made without them. They filed a suit in a Delaware state court seeking inspection rights.

The court ordered NavLink to provide the plaintiffs with board meeting minutes and with communications from NavLink's secretary regarding the minutes. The plaintiffs were also entitled to inspect corporate documents and communications concerning NavLink's budget and three-year plan

Dale Ross formed Big Little Farms, Inc. (BLF), in Trumbull County, Ohio, to breed and train racehorses. Dale failed to pay BLF's taxes, and the state cancelled its corporate status. Dale continued operating the farm business, however. Over a number of years, Dale's brother, Gene, loaned him funds to make improvements to BLF. At one point, Dale signed—as president of BLF Corporation—a promissory note to Gene and a mortgage on the farm. A few months later, Gene died. Gene's wife filed a claim against Dale and his wife seeking, in part, to foreclose on the mortgage. Then Dale died. Dale's wife claimed that the mortgage note her husband had signed was void because the corporation did not legally exist at the time he had signed it. Gene's wife argued that Dale's estate should not be able to avoid paying a note that Dale had knowingly signed as president of a corporation whose legal status had been revoked.

Ultimately, a state appellate court ruled that the mortgage note was valid. BLF was estopped from denying its corporate status for the purpose of invalidating the loan contract

Criminal acts

Under modern criminal law, a corporation may be held liable for the criminal acts of its agents and employees. Although corporations cannot be imprisoned, they can be fined. (Of course, corporate directors and officers can be imprisoned, and many have been.) In addition, under sentencing guidelines for crimes committed by corporate employees (white-collar crimes), corporations can face fines amounting to hundreds of millions of dollars.

First organizational meeting to adopt bylaws

Usually, the most important function of this meeting is the adoption of bylaws, which are the internal rules of management for the corporation. The bylaws cannot conflict with the state corporation statute or the articles of incorporation

Venture capital

Venture capital is capital provided to new businesses by professional, outside investors (venture capitalists, typically groups of wealthy investors and securities firms) Venture capital investments are high risk—the investors must be willing to lose all of their invested funds—but offer the potential for well-above-average returns in the future.

During the formation of a corporation, Gomez, one of the incorporators, transfers his property, Sunset Beach, to the corporation for 10,000 shares of stock at a par value of $100 per share for a total price of $1 million. After the property is transferred and the shares are issued, Sunset Beach is carried on the corporate books at a value of $1 million. On appraisal, it is discovered that the market value of the property at the time of transfer was only $500,000. The shares issued to Gomez are therefore watered stock, and he is liable to the corporation for the difference between the value of the shares and the value of the property.

Watered stock

watered stock.

When a corporation issues shares for less than their fair market value, the shares are referred to as watered stock. Usually, the shareholder who receives watered stock must pay the difference to the corporation (the shareholder is personally liable). In some states, the shareholder who receives watered stock may be liable to creditors of the corporation for unpaid corporate debts.

shareholder's derivative suit.

When the corporation is harmed by the actions of a third party, the directors can bring a lawsuit in the name of the corporation against that party. If the corporate directors fail to bring a lawsuit, shareholders can do so "derivatively" in what is known as a shareholder's derivative suit.

Preferred stock

an equity security with preferences. Usually, this means that holders of preferred stock have priority over holders of common stock as to dividends and payment on dissolution of the corporation.

The doctrine of respondeat superior

applies to corporations in the same way as it does to other agency relationships.

A corporation is referred to as a domestic corporation by:

by its home state (the state in which it incorporates).

John Murray, Stephen Hopkins, and Paul Ryan were officers, directors, employees, and majority shareholders of Olympic Adhesives, Inc. Merek Rubin was a minority shareholder. Murray, Hopkins, and Ryan were paid salaries. Twice a year, they paid themselves additional compensation—between 75 and 98 percent of Olympic's net profits, allocated according to their stock ownership. Rubin filed a suit against the majority shareholders, alleging that their compensation deprived him of his share of Olympic's profits. The court explained that a salary should reasonably relate to a corporate officer's ability and the quantity and quality of his or her services. The court found that a reasonable amount of compensation would have been 10 percent of Olympic's average annual net sales. Therefore, the additional compensation the majority shareholders paid themselves—based on stock ownership and not on performance—was exc

case point 18.3

Ballo Corporation needs office space. Stephanie Colson, one of its five directors, owns the building adjoining the corporation's headquarters. Colson can negotiate a lease for the space to Ballo if she fully discloses her conflicting interest and any facts known to her about the proposed transaction to Ballo and the other four directors. If the lease arrangement is fair and reasonable, Colson abstains from voting on it, and the other members of the corporation's board of directors unanimously approve it, the contract is valid.

conflict of interest