Closely Held Corporation
Voting Trust Requirements
One or more shareholders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust and transferring their shares to the trustee A voting trust becomes effective on the date the first shares subject to the trust are registered in the trustee's name; a voting trust is valid for not more than 10 years after its effective date unless extended De Facto Voting Trusts: arrangements "like" a voting trust Elements: Voting rights are separated from everything else Voting rights are intended to be irrevocable Purpose is to acquire voting control
Interstate Commerce
trade, commerce, transportation, or communication among the several States, or between any foreign country and any State, or between any State and any place or ship outside thereof; ALSO includes intrastate use of: Any facility of a national securities exchange or of a telephone or other interstate means of communication, OR Any other interstate instrumentality
Oppressive Conduct
violates minority shareholder's reasonable expectations (i.e. what induced them to invest / why they invested)
Going Concern
Commercial enterprise actively engaging in business w/ the expectation of indefinite continuance
Types of Stock
Common Stock: a class of stock generally entitling the holder to Preferred Stock: a class of stock generally giving its holder
Stock Subscriptions
-A subscription for shares entered into before incorporation is irrevocable for 6 months unless the subscription agreement provides a longer or shorter period -If a subscriber defaults in payment of money under a subscription agreement, the corporation may collect the amount owed as any other debt
Cumulative Voting
-A system in which each voter may allocate their shares among the candidates -Helps minority shareholders elect at least one representative Majority can avoid losing a majority of the BoD by using n*S/(D+1) + 1 n = # of board members desired S = total # of shares voting D = # of directors to be elected -Used mostly in mid-size closely held corporations -Shareholders D/N have a right to cumulate their votes for directors UNLESS the articles so provide A = 18 Shares B = 82 Shares Voting for five directors. Under straight voting, A can cast 18 votes for each, and B can cast 82 votes for each. Under *cumulative voting*, A has a total of 90 votes, and B has a total of 410 votes - and each can allocate those votes among the candidates.
Reasons to Go Public
-Additional capital raised for expansion -Liquidity of shares for shareholders -Publicly traded shares help lure employees w/ stock options -Publicly traded companies tend to be better known
4 Standards for Evaluating Whether Oppression Exists
-All shareholders must be treated equally, regardless of any business justification (liberal) -You must have a business reason to treat minority shareholders unequally -You just C/N have a bad reason to treat minority shareholders unequally -You can treat minority shareholders differently UNLESS the parties specifically contract around it (conservative)
Ultra Vires
-Beyond the scope of power allocated or granted by a corporate charter or bylaw -The validity of corporate action M/N be challenged on the ground that the corporation lacks or lacked power to act
When can a corporations act be challenged?
-By a shareholder against the corporation >The court may enjoin or set aside the act, if equitable -By the corporation against an incumbent or former director, officer, employee, or agent, OR -By the attorney general
Reasons Restrictions Aren't Used More Often in Closely Held Corporations
-Close corporation owners may be unsophisticated -Close corporation owners are often relatives or close friends, or business associates in other contexts -Investors and entrepreneurs are afraid to introduce the topic of protective agreements -The difficulty in foreseeing future circumstances
Promoters
-Entrepreneurs who put new businesses together -owe fiduciary duties to other participants in the venture (i.e. co-promoters, current shareholders, subsequent shareholders, current creditors, subsequent creditors, and/or the corporation itself -Usual mode of recovery is a civil recovery against the promoters or securities fraud under Rule 10b-5 -Liable unless the other party agreed to look elsewhere
Blurring the Lines
-Preferred can be subdivided to be given voting and profit rights in conjunction w/, or in preference to, common stock -Common stock can be classified as giving preference payments over other types of preferred stock
De Facto
-Pretend there is a corporation All persons purporting to act as or on behalf of a corporation, knowing there was no incorporation, are *jointly and severally liable* for all liabilities created while so acting A good faith attempt to incorporate negates the knowledge element
Dilution of Equity
-Protect against equity dilution by prohibiting sale/issuance under fair market value 3 shareholders, each own 1 share at a value of $4 (net assets = $12) 2 shareholders decide to issue 3 new shares for $2 each (under market value) If only 2 shareholders buy: Total assets of the company = $18 Each share is now worth $3 ($18 / 6 shares) The one shareholder who D/N purchase still owns only one share, but it is now only worth $3 -> he is diluted
Reverse Piercing the Corporate Veil
-Still focused on fairness/equity 1. Other Ways to Avoid the Corporate Format: a. A creditor may try to disregard a shareholder and get to a corporate entity b. An owner may try to avoid the corporate form in order to frustrate creditor claims c. Fraudulent Transfer: C/N get rid of assets in anticipation of oncoming liability for no consideration i. Deep Rock Doctrine: the claims of insiders are subordinate to the claims of outsiders b/c outsiders are separate entities 1. To allow insiders to circumvent the claims of outsiders would be unfair
Shares
-The Articles must set forth any classes of shares, and the number of shares of each class, that the corporation is authorized to issue >If more than one class of shares is authorized, the articles must prescribe a distinguishing designation for each class, and must describe the terms, including the preferences, rights, and limitations, of that class or series >All shares of a class must have terms that are identical w/ those of other shares of the same class -The articles must authorize: >One or more classes of share that together have unlimited voting rights, AND >One or more classes of shares that together are entitled to receive the net assets of the corporation upon dissolution
Piercing the Corporate Veil
-The judicial act of imposing personal liability on otherwise immune corporate officers, directors, and/or shareholders for the corporation's wrongful acts
Voting Agreements
-Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose A voting agreement is specifically enforceable
Common Law Factors to Consider for Piercing the Corporate Veil
-Undercapitalization --Adequately Capitalized: have enough money to cover what is reasonably foreseeable to occur (no necessarily for everything that could possibly happen) -Failure to observe corporate formalities Usually not a problem for larger corporations (lack thereof) dividends -Insolvency of the corporation at the time -Siphoning of corporate funds by the dominant shareholder (corporate payment of individual obligations) -Non-functioning of other officers and directors besides the D -Absence of corporate records --Usually not a problem for larger corporations -Corporation as a façade (non-participation in corporate affairs by shareholders other than D) -Fraudulent representation
The Board of Directors
-responsible for the oversight of the company's affairs, and is usually elected by the shareholders -can be comprised of shareholders, officers, both, or neither Directors manage the corporation and act through votes. Shareholders have the power to hire and fire directors. Directors cannot vote by proxy or voting agreement, directors can "break quorum" by leaving during a vote, and notice will only be required for a special meeting.
6 Elements a π Must Prove to Recover Under Rule 10b-5:
1. A material misrepresentation or omission by the D 2. Scienter 3. A connection between the misrepresentation or omission and the purchase or sale of a security 4. Reliance upon the misrepresentation or omission 5. Economic loss, AND 6. Loss causation
Documents for Formation
1. Articles of Incorporation: must be filed w/ state General Requirements to Form a Corporation Under the MBCA: i. Articles must be filed w/ the Secretary of State ii. Articles must be executed and signed by either the *chairman of the BoD* or an *officer* iii. Articles must set forth a *corporate name* A. A corporate name must contain the word "corporation," "incorporated," "company," or "limited," or an abbreviation of one of those words -Notice of being a corporation B. A corporate name must be *distinguishable* upon the records of the secretary of state -No subjective determinations iv. Articles must set forth the *number of shares* the corporation is authorized to issue v. Articles must set forth the *street address* of the corporation's initial registered office and the name of its initial registered agent at that office 2. Bylaws: generally describe how the corporation is going to be run The Articles of Incorporation must be filed with the state and will control if there are conflicts with the bylaws. 3. Minutes of Meetings: records of what happens during meetings
Remedies for Dissension
1. Nothing: only statutory remedies 2. Equitable Remedies of the Court -Election to Purchase in Lieu of Dissolution (buy-out): -Receivership or Custodianship 3. Injunctive Relief 4. Dissolution (most extreme remedy) (see above)
When are there No Preemptive Rights
>Shares issued as compensation to directors, officers, or employees, etc. >Shares issued to satisfy conversion or option rights created to provide compensation >Shares authorized in the articles that are issued w/i 6 months from the effective date of incorporation >Shares sold otherwise than for money
How do Deadlocks arise?
A 50/50 split on share ownership w/ straight voting High quorum and voting requirements for shareholder meetings so that a minority has an effective veto power High quorum and voting requirements at the BoD level An even # of directors, and each faction gets half of the directors
Legal Restrictions on Distributions
A BoD may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles and the following limitation: -No distribution may be made if, after giving it effect: >The corporation W/N be able to pay its debts as they become due in the usual course of business >The corporation's total assets would be less than the sum of its total liabilities + the amount that would be needed to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution The BoD may base a determination that a distribution is NOT prohibited either on financial statements or on a fair valuation or other method that is reasonable in the circumstances
Preferred Stock
A class of stock generally giving its holder: -Preferential claims to dividends and to corporate assets upon liquidation (usually) no voting rights -Types of Preferred Stock: >Cumulative: if dividends are not paid one year, they carry over to the next year and the common stock C/N get a dividend until the preferred shares are paid the full amount >Noncumulative: each year you hit the reset button; there is no carrying over effect >Partially Cumulative: cumulative to the extent there are earnings in a given year (that D/N get paid out as dividends), but, if the whole dividend C/N be paid, the excess D/N carry forward Participating Preferred: get an additional dividend after the common shares get paid a specified amount Classes of Preferred: the corporation can create different classes of preferred shares that will take before other classes
Shareholder Agreement (Pooling Agreement)
A contractual arrangement by which corporate shareholders agree that their shares will be voted as a unit.
Straight Voting
A corporate voting system in which a shareholder in board elections can vote their total shares for each candidate A majority shareholder will elect the entire BoD Used mostly in large & small corporations A = 18 Shares B = 82 Shares Voting for five directors. Under *straight voting*, A can cast 18 votes for each, and B can cast 82 votes for each. Under cumulative voting, A has a total of 90 votes, and B has a total of 410 votes - and each can allocate those votes among the candidates.
Dissolution by BoD
A corporation's BoD may propose dissolution for submission to the shareholders For a proposal to be adopted: 1. The BoD must recommend dissolution, AND 2. The shareholders entitled to vote must approve the proposal to dissolve at a meeting at which a quorum consisting of at least a majority of the votes entitled to be cast exists
Receivership or Custodianship
A court in a judicial proceeding brought to dissolve a corporation may appoint one or more receivers to wind up and liquidate, or one or more custodians to manage, the business and affairs of the corporation
Debenture
A debt secured only by the debtor's earning power, not by a lien on any specific asset
Dissolution by Initial Directors/Incorporators
A majority of the incorporators or initial directors of a corporation that H/N issued shares or H/N commenced business may dissolve the corporation by filing articles of dissolution
Proxy
A person who is authorized to vote another's stock shares Proxies: an appointment of a proxy is revocable UNLESS the appointment form or electronic transmission states that it is irrevocable and the appointment is coupled w/ an interest. Appointments coupled w/ an interest include the appointment of: A party to a voting agreement
Proxy Contest
A struggle between two corporate factions to obtain the votes of uncommitted shareholders -A proxy contest usually occurs when a group of dissident shareholders mounts a battle against the corporation's managers
Voting Trust
A trust used to hold shares of voting stock in a corporation and empowering the trustee to exercise the right to vote Note: the trust acts as custodian of the shares but is not a stockholder
Shareholder's List for Meeting
After fixing a record date for a meeting, a corporation shall prepare an alphabetical list of the names of all its shareholders who are entitled to notice of a shareholders' meeting The shareholders' list must be available for inspection by any shareholder The corporation shall make the shareholders' list available at the meeting
Shareholder Agreements
An agreement among the shareholders of a corporation is effective among the shareholders and the corporation even though it: -Eliminates the BoD or restricts the discretion or powers of the BoD -Establishes who shall be directors or officers of the corporation, or their terms of office or manner of selection or removal -Otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy An agreement authorized shall be: -Set forth in the articles or bylaws and approved by ALL persons who are shareholders, OR -In a written agreement that is signed by ALL persons who are shareholders, -AND Valid for 10 years, unless the agreement provides otherwise
Par Value
An arbitrary dollar value assigned to shares of stock, which, after being assigned, represents the minimum amount for which each share may initially be sold -(price) x (number of shares) = equity
Security
Any interest in Business
Distributions in a CHC
C/N refuse to make dividends for a reason other than a business reason Redemption can function like a distribution
Common Stock
Common Stock: a class of stock generally entitling the holder to: Vote on corporate matters (such as election of BoD) Receive net dividends after other claims and dividends have been paid Share in assets upon liquidation
Working Capital
Current assets (such as cash, inventory, and accounts receivable) less current liabilities; measures liquidity and the ability to discharge short-term obligations
Dissension
Deadlock Oppression
Taxation
Direct Taxation: the entity itself is taxed Double Taxation: shareholders are subject to double taxation b/c the corporation is taxed on its own profits and then the shareholders are taxed on the distributions they receive as well
Number of Directors and Shareholders; Capital Requirements
Each corporation must have a BoD A BoD must consist of one or more individuals, w/ the number specified in or fixed in accordance w/ the articles or bylaws Shareholder and capital requirements have largely disappeared in the U.S.
Requirements/Duties of Board of Directors
Each corporation must have a BoD All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its BoD To prove authority, get certified copies of resolutions
Duties of Officers
Each officer has the authority and shall perform the duties set forth in the bylaws or, to the extent consistent w/ the bylaws, the duties prescribed by the BoD Apparent Authority: officers can take usual and ordinary actions
Successor Liability
General Rule: successors are NOT liable A. 4 Exceptions: 1. Agreement 2. Merger 3. Continuation/reincarnation of the predecessor -Claim against X -Owners of X for Corp. Y -Y buys all assets of X (same people doing the same thing) 4. Fraud B. Continuity of Operation: same operation, but new/different people NOT fair to the successor corp. or new people
Defective Incorporation
Generally, *no corporation exists*, and there is no limited liability, until articles of incorporation are properly filed with the appropriate state office
Reasons NOT to Go Public
House keeping Must make internal affairs public Increased legal risks under SEA and Blue Sky laws SEC filing requirements Expensive to go public
Vacancy on the BoD
If a vacancy occurs on the BoD, if the directors remaining in office constitute fewer than a quorum of the BoD, they may fill the vacancy by the affirmative vote of a majority of all the directors remaining in office
Election to Purchase in Lieu of Dissolution (Buy-out)
In a proceeding to dissolve a corporation, the corporation may elect or, if it fails to elect, one or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares
Manipulative and Deceptive Devices
It shall be unlawful for any person by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange... to use or employ, in connection w/ the purchase or sale of any security, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission (SEC) may prescribe
Rule 10b-5: Employment of Manipulative and Deceptive Devices
It shall be unlawful for any person by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, -To employ any device, scheme, or artifice to defraud, -To make any untrue statement of a material fact or to omit to state a material fact, OR -To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection w/ the purchase or sale of any security There is a private c/a for Rule 10b-5 violations of ANY security Rule 10b-5 applies only to actual purchasers/sellers of securities Need scienter
Capital
Money or assets invested, or available for investment, in a business The total assets of a business, especially those that help generate profits The total amount or value of a corporation's stock (corporate equity)
Capital
Money or assets invested, or available for investment, in a business The total assets of a business, especially those that help generate profits The total amount or value of a corporation's stock; corporate equity
Ownership
Ownership: Shareholders: the owners who each own a part of the company through their interest represented by shares The Board of Directors: the BoD is responsible for the oversight of the company's affairs, and is usually elected by the shareholders The BoD can be comprised of shareholders, officers, both, or neither Officers: employees who run the company to effectuate the instructions of the BoD (e.g. the CEO, CFO, etc.)
Preemptive Rights
Protect against dilution of voting rights -The shareholders of a corporation D/N have a preemptive right to acquire the corporation's unissued shares except to the extent that the articles so provide -A statement in the articles that "the corporation elects to have preemptive rights" means that the following principles apply: -The shareholders of the corporation have a preemptive right to acquire proportional amounts of the corporation's unissued shares upon the decision of the BoD to issue them -A shareholder may waive his preemptive right
Transactions in Shares
Securities Fraud and Sales of Control
Quorum and Voting Requirements for Voting Groups
Shares entitled to vote may take action on a matter at a meeting only if a quorum of those shares exists w/ respect to that matter (Quorum = a majority of the votes entitled to be cast on the matter) If a quorum exists, action on a matter (other than the election of directors) by a voting group is approved if the votes cast w/i the voting group favoring the action exceed the votes cast opposing the action
Voting Systems
Straight voting Cumulative Voting
What controls between the Articles of Incorporation and the Bylaws?
The Articles of Incorporation must be filed with the state and will control if there are conflicts with the bylaws.
Issuance of Shares
The BoD may authorize shares to be issued for consideration consisting of any tangible or intangible property or benefit to the corporation, including cash, promissory notes, services performed, contracts for service to be performed, or other securities of the corporation -Before the corporation issues shares, the BoD must determine that the consideration received or to be received for shares to be issued is adequate
Staggered Voting for Directors
The articles may provide for staggering the terms of directors by dividing the total # of directors into two or three groups, w/ each containing 1/2 or 1/3 of the total #
Corporation by Estoppel
The association sues a 3rd party, and the 3rd party is estopped from denying that the association is a corporation A 3rd party sues the association as a corporation, and the association is precluded from denying that it was a corporation A 3rd party sues the association and the member of that association C/N deny its existence as a corporation where they participated in holding it out as a corporation A 3rd party sues the individuals behind the association, but is estopped from denying the existence of the corporation Either a 3rd party or the association is estopped from denying the corporate existence b/c of prior pleadings A court may, in the interest of fairness, prevent a party from denying that a de jure corporation exists (and, thus, that the shareholders have limited liability) under the doctrine of corporation by estoppel. Generally, this doctrine applies if: • a party dealt with an association as though it were a de jure corporation; • the party apparently believed the association was a de jure corporation, without fraud by the person representing the association; and • at the time, the association held itself out as a de jure corporation. Courts typically apply corporation by estoppel if a party to the transaction attempts to hold the shareholders personally liable, based solely on defective incorporation. Courts may also apply the doctrine to prevent the association itself from denying its corporate existence if a third party reasonably relied to her detriment on the association's status as a de jure corporation.
Record Date
The bylaws may fix or provide the manner of fixing the record date If the bylaws d/n fix or provide for fixing a record date, the BoD may fix a future date as the record date A fixed record date M/N be more than 70 days before the meeting or action requiring a determination of shareholders
Grounds for Judicial Dissolution
The court MAY dissolve a corporation in a proceeding by a shareholder if it is established that: a. The directors are deadlocked in the management of corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered, or the business and affairs of the corporation can no longer be conducted to the advantage of the shareholders generally, b/c of the deadlock; OR b. The directors have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent
Initial Public Offering (IPO)
The first public offering of a corporation's stock
Board of Directors
The governing body of a corporation, elected by the shareholders to establish corporate policy, appoint executive officers, and make major business and financial decisions -Traditional Rule: BoD C/N cede their discretion
Administrative Dissolution
The secretary of state may commence a proceeding to administratively dissolve a corporation IF: The corporation D/N pay franchise taxes The corporation D/N deliver its annual report The corporation is w/o a registered agent or registered office, OR The corporation's period of duration stated in its articles expires
Leverage
To provide a borrower w/ credit or funds to improve speculative ability and to seek a high rate of return; to supplement available capital w/ credit or outside funds If interest rates are low, it makes more sense to borrow if you believe you will get a greater return on your investment than the interest rate you will pay on the loan Interest payments on a loan are tax deductible from the corporation's earnings, whereas distributions and dividends are NOT
Removal of Directors by Shareholders
Under Cumulative Voting: a director M/N be removed if the # of votes sufficient to elect him under cumulative voting is voted against his removal Under Straight Voting: a director may be removed only if the # of votes cast to remove him exceeds the number of votes cast not to remove him
DeWitt Factors for Piercing the Corporate Veil
Under-capitalization Failure to observe corporate formalities (Non-payment of) dividends Insolvency of the corporation Siphoning of corporate funds by the dominant shareholder Non-functioning of other officers and directors besides the defendant Absence of corporate records Corporation as a façade (non-participation in corporate affairs by shareholders other than defendant)
Scienter
a mental state in which one has knowledge that one's action, statement, etc., is wrong, deceptive, or illegal
Delaware Law Recognizes Piercing the Corporate Veil in Instances of
a. Fraud b. Alter-ego: two entities function as one, thus it would be unfair to treat them separately
De Jure
abides by the law
Asset Acquisition
acquisition of a corporation by purchasing all its assets directly from the corporation itself, rather than by purchasing shares from its shareholders
Bond
an obligation secured by a lien or mortgage on corporate property
Alter Ego Factors (Delaware Law)
i. Alter Ego Factors: -Adequate capitalization -Solvency -Dividends -Records & formalities -Siphoning corporate funds -Façade ii. Changing Hats: clearly define roles at various points in time to avoid intermingling
Oppression
bottom-line is NOT getting any $ (distinction between employment and shareholder interests; oppression = when shareholder interests are threatened) -a concept that depends on views of fairness and equity - so there are a number of different views of when a minority shareholder is "oppressed."
Power
corporations have the same powers as an individual to do all things necessary or convenient to carry out its business and affairs
Officers
employees who run the company to effectuate the instructions of the BoD (e.g. the CEO, CFO, etc.)
Duration
every corporation has *perpetual* duration and succession in its corporate name
Purpose
every corporation has the purpose of engaging in any lawful business unless a more limited purpose is set forth in -the articles of incorporation The articles need NOT set forth any of the enumerated corporate powers
Difference Between Contract and Tort
factors may apply differently Tort: no chance to research the other party -> more sympathy Contract: parties have a better opportunity to research each other and prepare/assume the risk
Restrictions on Share Ownership
i. The articles, bylaws, an agreement among shareholders, or an agreement between shareholders and the corporation may impose restrictions on the transfer or registration of transfer of shares of the corporation ii. A restriction on the transfer or registration of transfer of shares is valid and enforceable if the restriction is authorized by this section and its existence is noted conspicuously on the front or back of the certificate Test for Enforceability of Restrictions = conspicuous & reasonable Conspicuous = easily identifiable A restriction is NOT enforceable against a person w/o knowledge of the restriction A restriction on the transfer or registration of transfer of shares is authorized: To maintain the corporation's status To preserve exemptions For any other lawful purpose A restriction on the transfer or registration of transfer of shares may: Obligate the shareholder first to offer the corporation or other persons an opportunity to acquire the restricted shares Obligate the corporation or other persons to acquire the restricted shares
Liability
shareholders in a corporation are shielded from liability for the obligations of the corporation
Merger
the absorption of one organization that ceases to exist into another that retains its own name and identity and acquires the assets and liabilities of the former
Shareholders
the owners who each own a part of the company through their interest represented by shares Do not play an active role in management They have annual meetings, for which written notice is required 10-60 days before the meeting. Shareholders are permitted to vote by proxy or create voting agreements. In general, a majority of all outstanding shares entitled to vote (known as a quorum) must be present to hold a valid vote. Shareholders have the power to hire and fire directors.
Capitalization
the total amount of long-term financing used by a business, including stocks, bonds, retained earnings, and other funds