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Terms in this set (136)
Any association of two or more people who carry on a business as co-owners.
Can come into existence by operation of law, with no formal papers signed or filed.
Any partnership is a "general" one unless special requirements are met and complied with.
Can only be created where: (1) there is a written agreement among partners; and (2) a formal document is filed with state officials.
Two types of partners in limited partnerships
1. general partner
2. limited partner
General Partner (limited partnerships)
Partners who are each liable for all the debts of the partnership.
Limited Partner (limited partnerships)
Partners who are not liable for the debts of the partnership beyond the amount they have contributed.
Shareholder Liability in Corporations
Limited to the amount he invested
Depends on whether the partner is limited or general.
Limited Liability Partnership
Third type of partnership where each partner may participate fully in the business's affairs without becoming liable for the entity's debts.
Management of a Corporation
Centralized management. The shareholders participate only by electing the board of directors. The board of directors supervises the company's affairs, with day to day control resting with the officers (ie high level executives appointed by the board).
Management of a Partnership
Management is not centralized.
In a general partnership, all partners have an equal voice (unless they otherwise agree).
In a limited partnership, all general partners have an equal voice (unless they otherwise agree), but limited partners may not participate in management.
Continuity of Existence
A corporation has perpetual existence.
A general partnership is dissolved by the death (or the withdrawal) of a general partner.
A limited partnership is dissolved by the withdrawal or death of a general partner, but not a limited partner.
Ownership interests in a corporation are readily transferable (the shareholder just sells stock).
A partnership interest, by contrast, is not readily transferrable (all partners must consent to admission of a new partner).
Federal Income Tax for Corporations
Taxed as a separate entity.
Files its out tax return showing profits and losses, and pays its own taxes independently of the tax position of the stockholders.
This may lead to "double taxation" of dividends (a corporate level tax on corporate profits, and a shareholder level tax on the dividend).
A corporate level tax on corporate profits, and a shareholder level tax on the dividend.
Federal Income Tax for Partnerships
Not separately taxable entities.
Must file an information return, but the actual tax is paid by each individual.
Double taxation is avoided.
A partner can use losses from the partnership to shelter from tax certain income from other sources.
Federal Income Tax for Subchapter S Corporations
If the owners / stockholders of a corporation would like to be taxed approximately as if they were partners in a partnership, they can do this by electing to be treated as an S Corp.
Does not get taxed at the corporate level, unlike a regular corporation; instead, each shareholder pays a tax on his portion of the corporation's profits.
Corporation Superior to Partnership
(1) where the owners want to limit liability;
(2) where free transferability of interests is important;
(3) where centralized management is important (many owners); and
(4) where continuity of existence in the face of withdrawal or death of an owner is important.
Partnership Superior to Corporation
(1) simplicity and inexpensiveness of creating and operating the enterprise are important; or
(2) the tax advantages are significant, such as avoiding double taxation or sheltering income.
Limited Liability Corporation
Fastest growing form of organization.
Has aspects of corporations and partnerships.
Advantages of LLC vs Standard Partnership for Liability
In LLCs a "member" is liable only for the amount of his capital contribution, even if he actively participates in the business.
Members can elect whether to have the entity treated as a partnership or a corporation.
If they elect partnership treatment, the entity becomes a "pass through entity," and thus avoids double taxation of dividends that shareholders of the standard corporation suffer from.
LLC Operating Agreement
Owners (called members) must agree among themselves how the business will operate (eg: what kind of vote is needed to sell the LLC's assets, or whether the entity will be managed by its members or by a separate set of managers).
Usually done by an agreement in writing.
The LLC is bound by this agreement, even though only members sign.
Implied covenant of good faith and fair dealing.
State of Incorporation
Incorporators usually choose between their headquarter state and Delaware.
A closely held corporation should be incorporated in the state where the corporation's principal place of business is located.
A publicly held corporation should be incorporated in Delaware (because of its well defined, predictable, body of law, and its slight pro management bias).
Articles of Incorporation
To form a corporation, incorporators file this document with the Secretary of State.
It can be amended at any time after filing. However, any class of stockholders who would be adversely affected by the amendment must approve the amendment by a majority vote.
After the corporation is formed these must be adopted.
They govern the corporation's internal affairs (date, time and place for annual meeting; number of directors; listing of officers; what constitutes quorum for directors' meetings; etc).
They are usually not filed with the Secretary of State, and may usually be amended by the board or shareholders.
One who takes initial steps to form corporation.
May be liable for debts he contracts on behalf of the to be formed corporation.
If he enters into a contract in the corporation's name, and he knows that the corporation has not yet been formed (but the other party doesn't know this) then he will be liable under the contract. But if the corporation is later formed and adopts the contract he may escape liability.
If the contract says that the corporation has not yet been formed, the liability depends on what the court finds to be the parties' intent.
- Never formed, or immediately defaults: if the corporation is never formed, or is formed but then immediately defaults, he will probably be liable.
- Formed and then adopts: if the corporation is formed, and then shows its intent to take over the contract (ie, adopts it), then the court may find that both parties intended for the p to be released from liability (a "novation").
Liability of corporation (for promoter purposes)
If the corporation did not exist at the time the promoter signed a contract on its behalf, the corporation will not become liable unless it "adopts" the contract. Adoption may be implied.
Promoter's fiduciary obligation
During the pre incorporation period, he has a duty to the to be formed corporation.
He may not pursue his own profit at the corporation's ultimate expense.
De Facto Corporation
A corp that is partially but defectively or incompletely formed.
(1) A valid law under which such a corp can be lawfully organized;
(2) An attempt to organize thereunder (good faith or colorable attempt);
(3)Actual user of the corporate franchise.
State: it is sufficiently formed to be immune from attack by everyone but the state.
Corporation by Estoppel
Whereby a creditor who deals with the business as a corporation , and who agrees to look at its assets rather than the shareholders' assets, will be estopped from denying the corporation's existence.
Piercing the Corporate Veil
The action of a court to disregard the corporate entity and hold the shareholders personally liable for corporate debts and obligations.
Piercing the Corporate Veil for Individual Shareholders (Factors)
1. tort vs contract (voluntary creditor): courts are more likely to pierce the veil in a tort case (where the creditor is involuntary) than in a contract case (where the creditor is voluntary);
2. fraud: veil piercing is more likely where there has been a grievous fraud or wrongdoing by the shareholders (eg the sole shareholder siphons out all profits, leaving the corporation without enough money to pay its claim);
3. inadequate capitalization: most important, veil piercing is most likely if the corporation has been inadequately capitalized. But most courts do not make inadequate capitalization alone enough for veil piercing.
a. zero capital: when the shareholder invests no money whatsoever in the corporation, courts are especially likely to pierce the veil, and may require less of a showing on the other factors than if the capitalization was inadequate but non zero.
b. siphoning: capitalization may be inadequate either because there is not enough initial capital, or because the corporation's profits are systematically siphoned out as earned. But if capitalization is adequate, and the corporation has unexpected liabilities, the shareholders' failure to put in additional capital will generally not be inadequate capitalization.
4. failure of formalities: lastly the court is more likely to pierce the veil if the shareholders have failed to follow corporate formalities in running the business (shares are never formally issued, directors' meetings are not held, shareholders co-mingle personal and company funds).
Summary: at least 2 of the 4 factors must be present for a court to pierce the veil; most commonly inadequate capitalization plus failure to follow corporate formalities.
Piercing the Corporate Veil of a Parent Company
If shares are held by the parent company, the court may pierce the veil and make the parent company liable for the debts of the subsidiary.
The general rule is that the corporate parent shareholder is not liable for the debts of the subsidiary.
The fact that the parent may dominate the affairs of the subsidiary will not by itself be enough to give rise to veil piercing. Thus the fact that the parent drains the excess cash from the subsidary, demands a veto power over significant decisions, or otherwise exercises some degree of control over its operations, will not suffice for piercing.
So long as the degree of control by the parent over the subsidiary is within the bounds usually found in corporate America, creditors will probably not be able to attack the parent company's assets.
Only if the parent and subsidiary operate as a single economic entity will the veil generally be pierced, assuming there is no fraud on creditors.
Factors for Piercing the Corporate Veil of a Parent Company
1. the parent and subsidiary fail to follow separate corporate formalities for the 2 corporations (both have the same board, and do not hold separate directors' meetings);
2. the parent and subsidiary are operating pieces of the same business, and the subsidiary is undercapitalized.
3. the public is misled about which entity is operating which business;
4. assets are intermingled between parent and subsidiary; and
5. the subsidiary is operated in an unfair manner (eg forced to sell at cost to parent).
Traditional Corporate Structure
1. Shareholders: act principally by: (1) electing directors; and (2) approving or disapproving fundamental or non-ordering changes (eg mergers)
2. Directors: manage the corporation's business. They formulate the policy and appoint officers to carry out the policy.
3. Officers: administer the day to day affairs of the corporation, under supervision of the board.
This allocation of powers usually may be modified by the corporation when appropriate. THis often done in the case of closely held corporations.
Powers of Shareholders
1. They have the power to elect and remove directors.
- Election: normally they elect the directors at the annual meeting of shareholders. So, directors usually serve a one year term.
- Vacancies: they usually have the right to elect directors to fill vacancies on the board, but the board also usually has this power.
- Removal: most statutes allow them to remove directors even without cause today (at common law they had little power to remove a director during his term of office).
2. They can amend the articles of incorporation or the bylaws.
- Some states significantly limit the content of bylaws, and thus limit the ability of stockholders to change how the corporation functions.
3. They get to approve or disapprove of fundamental changes not in the ordinary course of business (mergers, sales of substantially all of the company's assets, or dissolution).
Power of Directors
1. Shareholders can't give orders: thus shareholders usually can't order the board to take any particular action.
2. Supervisory role: the board does not operate the corporation day to day. Instead it appoints officers, and supervises the manner in which the officers conduct the day to day affairs.
Cumulative vs. Straight Voting
Cumulative: the number of total votes that each SH may cast is first computed and each SH is permitted to distribute these votes as he sees fit over one or more candidates.
- Increases minority participation on the board of directors.
- Default: some states require cumulative voting; those that do not require it, require you to opt out of it (cumulative is the default).
Straight: one vote per share per candidate position.
- The SH with 51 percent of the vote elects the entire board.
- Majority always wins; gives the minority no representation at all—the majority can control almost everything.
Number of Directors
Usually fixed in either the articles or bylaws.
Most statutes require at least 3.
Most statutes allow a variable (minimum and maximum) size for the board, rather than a fixed size. If variable, then the board gets to decide how many directors within the range there should be.
Filling Vacancies on the BoD
Either the shareholders or the board can fill.
Regular vs special: regular is one which occurs at a regular interval (usually specified in bylaws). All others are special.
No notice is necessary for a regular meeting. Prior notice is required for special.
The board may only act if a quorum is present (a majority of the total directors in office). Bylaws may lower the number required or require a super majority.
Act of the Board
Action only by a vote of majority of the directors present at the meeting.
The board may only take action at meetings, not by individual action of the directors.
Exceptions to meeting requirement:
(1) unanimous written consent: directors may act without a meeting if there is unimous written consent to the proposed action.
(2) telephone meetings
(3) ratification: if the board learns of an action taken by an officer, and the board does not object, they may have the action ratified, or the board may be estopped from dishonoring it. In either case the result is as if the board had formally approved the action in advance.
A director may disassociate himself from the board by filing a written dissent, or by making an oral dissent that is entered in the minutes of the meeting. This will shield the director from any possible liability for the corporate action.
The board may appoint various committees.
Generally, the committee may take any action which could be taken by the full board (but they can't fill board vacancies, amend the articles or bylaws, propose actions for shareholder approval, or authorize share repurchases).
An executive of the corporation, typically appointed by the board of directors.
Can be hired and fired by the board (firing can be without cause).
Is an agent of the corporation, and his authority is analyzed under agency principals. Does not have the automatic right to bind the corporation. Instead, one of four doctrines must be used to find that the officer could bind the corporation.
Authority to Act for the Corporation (Doctrines)
1. Express actual authority
2. Implied actual authority
3. Apparent authority
Express Actual Authority (Authority to Act for the Corporation)
Can be given to an officer either by the corporation's bylaws, or by a resolution adopted by the board.
Implied Actual Authority (Authority to Act for the Corporation)
Authority that is inherent in the office. Usually, it is authority that is inherent in the particular post occupied by the officer.
President: generally held to have authority to engage in ordinary business transactions such as hirign and firing of non officer level employees and entering into ordinary course contracts. Does not have implied authority to bind the corporation to non ordinary course contracts such as Ks for real estate of for the same of all of the corporations assets.
Secretary: authority to certify the records of the corporation, including the resolutions of the board. A secretary's certificate that a given resolution was duly adopted by the board is binding on the corporation in favor of a third party who relies on the certificate.
Removal: the board may always explicitly remove implied authority that would otherwise exist.
Apparent Authority (Authority to Act for the Corporation)
If the corporation gives observers the appearance that the agent is authorized to act as he is acting.
Two requirements: (1) the corporation, by acts other than those of the officer, mut indicate to the world that the officer has authority to do the act in question; and (2) the plaintiff must be aware of those corporate indications and rely on them.
President: apparent authority flows merely from the fact that the corporation has given him that title, and he will then have apparent authority to enter into ordinary course arrangements.
Ratification (Authority to Act for the Corporation)
If a person with actual authority to enter into a transaction learns fo a transaction by an officer, and either expressly affirms it or fails to disavow it, the corporation may be bound.
Usually, P will have to show that the corporation either received benefits under the contract, or that P himself relied to his detriment on the existence of the contract.
Held annually (other meetings are "special" meetings).
Special meetings may be called by the board, or anyone authorized to call a meeting.
Some states allow meetings to occur on the internet.
For a vote of a shareholders' meeting to be effective, there must be a quorum present. This means a majority of outstanding shares. The amount may be changed, but many states don't allow the percentage to be reduced below 1/3.
Once present, the shareholders will be deemed to have approved of the proposed action only if a majority of the shares present actually vote in favor of the proposed action.
Once present, the quorum is deemed to exist for the rest of the meeting even if shareholders leave.
Shareholders may act by unanimous written consent without a meeting.
Some states allow non unanimous written consent.
Shareholder Inspection of Books and Records
State law gives shareholders the right to inspect books and records (under common law they must show a "proper purpose" for doing so).
Shareholders can inspect corporate records in general.
Which Shareholders can Inspect
Beneficial owners as well as holders of record can inspect books and records.
Some statutes limit to shareholders who have held their shares for a certain amount of time or hold more than a certain percentage of total shares.
1. Evaluation of investment: a shareholder's desire to evaluate his investment will usually be proper.
2. Unrelated personal goal: pursuit of unrelated personal goals will usually NOT be proper.
3. Deal with other shareholders: if the holder wants to get access to the shareholder's list to contact his fellow shareholders to take group action concerning the corporation, this will usually be proper.
4. Social / political goals: if the holder is pursuing only social or political goals that are not closely related to the corporation's business, this purpose will usually NOT be proper.
5. Multiple purposes of which one is proper: inspection must be allowed as long as there is at least one proper purpose, the presence of an improper purpose is irrelevant.
In most states, the corporation is not required to send an annual report or other financial info to the shareholder.
But federal law requires publicly held corporations to send a report, and some states require this for all corporations.
Director's Right of Inspection
Has a broad, virtually automatic, right of inspection (most states deny him the right if he is acting with "manifestly improper motives").
Publicly Held Company
1. have stock that is traded on a national securities exchange; or
2. have assets of more than $10 million and a class of stock held of record by 500 or more people.
Whenever management or a third party want to persuade a shareholder to vote in a certain way, the solicitation must comply with the SEC proxy rules.
Proxy Disclosure and Filing Requirements
Filing: any proxy solicitation documents that will be sent to shareholders must be filed with the SEC.
Proxy Statement: every proxy solicitation must be accompanied or preceded by a proxy statement.
Annual Report: must be sent to every shareholder.
Anti fraud: any false or misleading statements or omissions in a proxy statement are banned by SEC rules.
Requirements for proxy
A card which the shareholder signs, and on which he indicates how he wants to vote. SEC rules govern the format of this card.
Method by which the shareholder indicates to management that he is voting for the management's slate of directors.
The card will also be the shareholder's way of indicating how he votes on some major non election issue, such as whether the company should merge.
The proxy is a method of casting shareholder votes in all situations except where the shareholder attends the shareholder's meeting.
Revocation of Proxies
it is revocable by the shareholder, even it it says it is not.
But if it says it is revocable and "coupled with interest" then it is not revocable.
A proxy is coupled with interest when the recipient of the proxy has a property interest in the shares, or at least some other direct economic interest in how the vote is cast (ex: a shareholder pledges his shares in return for a loan from a bank. The pledge is an interest, so the proxy will be irrevocable while the loan is outstanding).
Requirements for Implied Private Actions under Proxy Rules
1. Materiality: P must show that there was a material misstatement or omission in the proxy materials. The omitted fact is material if it would have "assumed actual significance in the deliberations of a reasonable shareholder."
2. Causation: P must show a causal link between the misleading proxy materials and some damage to the shareholders. P does not have to show that the falsehood or omission directly caused damage to the shareholders, only that the proxy solicitation itself was an essential part of the transaction (ex: if holders have to approve a merger, any material defect in the proxy materials will be deemed to have caused damage to the holders. since the proxy solicitation was an essential part of carrying out the merger).
3. Standard of Fault: P must show that D was at fault in some way. If the D is an "insider" (the corporation itself. its officers, directors, or employees), P only has to show that D was negligent. Some courts have also found outside directors and other outsiders liable for errors or omissions under the proxy rules, where the outsider was negligent.
Remedies: (1) injunction against proposed transaction; (2) set aside an already completed transaction; (3) obtain damages for himself and other shareholders, if he can prove monetary injury.
Regulation FD (Fair Disclosure)
Enacted by the SEC.
Stops company from making "selective disclosure." Selective disclosure occurs when the company gives certain professional investors info that the public isn't given until later.
(1) if a public company intends to release material nonpublic info to certain professional investors, the company must disclose the info simultaneously to the public.
(2) and if the public company realizes that it has unintentionally disclosed material nonpublic info to such a professional investor, it must cure the problem by then promptly disclosing that info to the public.
Passed by Congress in 2002, increases the responsibilities of people in charge of running the finances of public companies.
1. CEO/CFO Certification: CEO and CFO must certify the accuracy of each quarterly and annual filing with the SEC.
2. Rules about Audit Committee: each member of the company's audit committee must be independent of the company.
3. Auditor Independence: the company's outside auditors must also be more independent than previously. The auditors may no longer do other tasks for the company, such as bookkeeping, designing the computer system that does financial record keeping, etc.
4. Whistleblower Protections: it's now a crime to take any action against a person on account of that person's provision of truthful info to govt or to the person's boss concerning the possible commission of a federal offense.
A corporation with (1) a small number of stockholders, (2) the lack of any ready market for the corporation's stock, and (3) substantial participation by the majority stockholder(s) in the management, direction, and operations of the corporation.
Shareholder Voting Agreement
An agreement in which 2 or more shareholders agree to vote together as a unit on certain or all matters. Some expressly provide how votes will be cast. Other agreements merely commit the parties to vote together.
They are generally valid.
Enforced by: (1) proxy (agreement may require each signatory to give a third person an irrevocable proxy to vote the signers' shares in accordance with the agreement), or (2) specific performance.
The shareholders who are part of the arrangement convey legal title to their share to one or more vote trustees, under the terms of an agreement.
The shareholders become beneficial owners - they receive a certificate representing their beneficial interest, and get dividends and sale proceeds but no longer have voting power.
Classified Stock and Voting Weight
Shareholders may reallocate their voting power (and give minority voters a bigger voice) by using classified stock. The corporation sets up two or more classes of stock, and gives each class different voting and financial rights.
Agreements Restricting the Board's Discretion
Courts will uphold as long as: (1) does not injure any minority shareholder; (2) does not injure creditors or the public; (3) does not violate any express statutory provision.
Share Transfer Restrictions
Shares in a corp are freely transferable unless there is an express restriction on the transferability of shares. Such restrictions constitute contractual obligations that limit the power of owners to freely transfer their shares.
An agreement by which a SH is obligated to sell, and the corp or other SHs are obligated to buy, shares at a designated or computable price upon the occurrence of specified triggering events. There are two types:
1. Cross-purchase: each SH agrees to personally purchase his proportionate share of the other SHs in the event of their death.
2. Stock-redemption: the corp becomes a party to the agreement as well as the SHs; corp would agree to redeem or purchase the shares of the first SH to die.
Similar to a buy-sell agreement except an option does not guarantee the SH a specified price.
Duty of Care
A director or officer must behave with a level of care which a reasonable person in similar circumstances would use.
Objective standard: director is held to the conduct that would be exercised by a reasonable person in the director's position.
- if the director has special skills that go beyond what an ordinary director would have, he must use those skills.
Breach of Duty of Care
If a director or officer violates the duty, and the corporation loses money, they will be personally liable to pay money damages.
If the board approved a transaction without using due care, the court may grant an injunction against it (if the transaction has not yet been consummated).
Passive Negligence (Duty of Care)
A director will not be liable for merely failing to detect wrongdoing by officers or employees.
Director on Notice: if the director is on notice of facts suggesting wrongdoing, he cannot close his eyes to avoid them.
Monitoring Mechanisms: It may constitute a violation of due care for directors not to put into place monitoring mechanisms.
Directors will have Liability for Poor Oversight if
(1) the directors utterly failed to implement any reporting or information system or controls; or
(2) having implemented such system or controls, the directors consciously failed to monitor or oversee the system's operations, thus disabling themselves from being informed of the risks or problems requiring their attention.
Business Judgment Rule
A rule that immunizes corporate management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and are within both the power of the corporation and the authority of management to make.
Business Judgment Rule Requirements
1. No self dealing: the director will not qualify for protection if he has an interest in the transaction.
2. Informed decision: the decision must have been an informed one, meaning the director must have gathered at least a reasonable amount of info about it before making it.
3. Rational decision: the director must have rationally believed the decision was in the corporation's best interest.
Business Judgment Rule Exceptions
1. Illegal: if the act taken or approved by the director is a violation of a criminal statute, the D will lose the benefit of the business judgment rule.
2. Pursuit of social goals: some courts may hold the business judgment rule inapplicable if the director is pursuing his own social or political goals.
Duty of Loyalty
a fiduciary duty owed by an agent not to act adversely to the interests of the principal.
Self Dealing Transaction
(1) a key player (director, officer, etc) and the corporation are on opposite sides of the transaction;
(2) the key player has helped influence corporation's decision to enter the transaction; and
(3) the key player's personal financial interests are at least potentially in conflict with the corporation.
Fair Self Dealing Transaction
If the transaction is fair, the court will uphold it regardless of whether it was ever approved by disinterested directors or ratified shareholders.
Waste or Fraud Self Dealing Transaction
If the transaction is so fair it amounts to waste or fraud against the corporation, the court will usually void it at the request of a stockholder. This is true even if it was approved by disinterested directors or ratified shareholders.
A transaction will not be invalidated as constituting waste unless it is "an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corp has received adequate consideration."
Ways to Uphold a Self-Dealing Transaction
1. Disclosure + board approval
2. Disclosure + ratification by shareholders
3. Show the transaction was fair when made
Disclosure plus Board Approval (Self Dealing)
A transaction may not be avoided by the corporation if it was authorized by a majority of the disinterested directors, after full disclosure of the nature of the conflict and transaction.
What must be disclosed: (1) the material facts about the conflict, and (2) the material facts about the transaction.
When must the disclosure be made: some courts say before the transaction, some say it must be ratified after the fact.
If (1) he or an immediate family member have a financial interest in the transaction; or (2) he or a family member have a relationship with the other party to the transaction that would reasonably be expected to affect his judgment about the transaction.
Disclosure plus Shareholder Ratification (self dealing)
A self dealing transaction will be validated if it is fully disclosed to the shareholders and then ratified by a majority of them.
Courts are split on whether the ratification must be a majority of disinterested shareholders or just all shareholders.
Fairness (self dealing)
A self dealing transaction can be validated by a showing that it is fair to the corporation.
A fair transaction will be upheld even if it was never disclosed.
Corporate Opportunity Doctrine
A director or executive may no usurp for himself a business opportunity that is found to belong to the corporation.
Effect: if he is found to have taken a corporate opportunity, the taking is per se wrongful to the corporation, and the the corporation may recover damages equal to the loss suffered or even profits it would have made had it been given the chance to pursue the opportunity.
Delaware Corporate Opportunity Factor Test
A business opportunity is a corporate opportunity if it meets the following requirements:
1. the corporation is financially able to exploit the opportunity;
2. the opportunity is within the corporation's line of business;
3. the corporation has an interest or a reasonable expectancy in the opportunity; and
4. if the director or officer were to embrace the opportunity, he would thereby be placed in a conflict with his duties to the corporation.
a person owns a controlling interest if he has the power to use the assets of the corporation however he chooses. A majority owner always has a controlling interest.
The Sale of Control
Generally, a controlling shareholder may sell his control block for a premium and may keep the premium for himself.
Exceptions: (1) looting exception, (2) the sale of vote exception, (3) the diversion of collective opportunity exception.
The controlling shareholder may not sell his control block if he knows or suspects that the buyer intends to "loot" the corporation by unlawfully diverting its assets.
Sale of Vote Exception
The controlling shareholder may not sell for a premium where the sale amounts to a sale of his vote.
This exception doesn't apply if the controlling shareholder owns a majority interest.
The Diversion of Collective Opportunity Exception
A court may find that the corporation had a business opportunity and that the controlling shareholder has constructed the sae of his control block in such a way as to deprive the corporation of this business opportunity.
Refers to the buying or selling of stock in a publicly traded company based on material, non public info about the company.
Only illegal if it occurs as a result of someone's willful breach of a fiduciary duty.
Examples that are illegal:
(1) buying before disclosure of good news;
(2) selling before disclosure of bad news.
SEC Rule 10b-5
Makes it unlawful to:
(1) employ any device, scheme, or artifice to defraud;
(2) to make any untrue statement of a material fact or to omit to state a material fact; or
(3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
All three of these types of conduct are forbidden only if they occur in connection with the purchase or sale of any security.
Bars most types of insider trading.
Requirements for Private Right of Action for Rule 10b-5
1. purchaser or sell: P must have been a purchaser or seller of the company's stock during the time of non disclosure
2. traded on material, non public info: D must have misstated or omitted a material fact (a fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important)
3. special relationship: if the claim is based on insider trading, D must be shown to have a special relationship with the issuer, based on some kind of fiduciary duty to the issuer
4. scienter: D must be shown to have acted with scienter (he must be shown to have had an intent to deceive, manipulate or defraud)
5. reliance and causation: P must show that he relied on D's misstatement or omission, and that the misstatement or omission was the proximate cause of his loss
6. jurisdiction: there is a federal jurisdiction requirement
Has some sort of fiduciary relationship with the issuer that requires him to keep the non public info confidential.
A person who (1) receives info given to him in breach of the insider's fiduciary responsibility; (2) who knows that the breach has occurred; and (3) who has received some benefit from the breach.
A lawsuit filed by one or more shareholders of a corporation against that organization's management (usually brought against a director or officer). This suit is brought to benefit the corporation directly and its shareholders indirectly.
Not all suits by shareholders are derivative, sometimes a shareholder may sue the corporation or insiders directly.
Most suits brought against insiders for breach of fiduciary duties (care or loyalty) are derivative.
Test to Distinguish between Derivative and Direct Suits
1. who suffered the harm, the corporation, or the suing stockholders individually?
2. who would receive the benefit of any recovery or other remedy, the corporation or the stockholders individually?
So if the shareholders have suffered the harm, and they would get the benefit of any recovery, the action is direct.
Requirements for Derivative Suit
1. contemporaneous ownership: P must have owned his shares at the time of the transaction of which he complains.
- continuous wrong exception: P can sue to challenge a wrong that began before he bought his shares but that continued after the purchase.
2. continuing ownership: P must continue to own the shares not only until the time of the suit, but until the moment of the judgment.
3. demand on board: P must make a written demand on the board of directors before commencing the derivative suit.
4. demand on shareholders: many states require P to also make a demand on the shareholders instituting the derivative suit.
Demand on board is excused where it would be futile. It will be deemed futile if the board is accused of having participated in the wrongdoing.
Demand Required and Refused
If the board rejects the demand, the result depends on who the D is:
1. unaffiliated 3rd party: if the suit is against a 3rd party who is not a corporate insider, P will almost never be permitted to continue his suit after the board rejected it.
2. suit against insider: where the suit is against an insider, P has a better chance of having the board's refusal to pursue the suit be overridden by the court.
The corporation appoints an independent committee of directors to study whether the suit should be pursued.
Usually, the committee will conclude that the suit should not be pursued.
The court will usually give the committee recommendation the protection of the business judgment rule.
Settlement of Derivative Suits
Most courts require that any settlement be approved by the court. The court must be convinced that the settlement is in the best interests of the corporation and its shareholders.
The most important factor is the size of the net financial benefit to the corporation under the settlement and the probably net benefit if the case were tried.
The shareholders must be given notice of any proposed settlement of a derivative action, as well as the opportunity to intervene in the action to oppose the settlement.
All payments made in connection with the derivative action must be received by the corporation, not by the plaintiff.
Merger Type Deals
Transaction where the shareholders of little corp end up mainly with stock in big corp as their payment for surrendering control of little corp and its assets.
4 main structures: (1) statutory, (2) stock swap, (3) stock for assets exchange, (4) subsidiary merger
By following procedures set out in the state corporation statute, one corp can merge into another, with the former ceasing to have any legal identity, and the latter continuing in existence.
Consequence: after the merger, big owns all of little's assets, and is responsible for all of its liabilities. The shareholders of little now own stock in big.
Stock for Stock Exchange (stock swap)
Big corp makes a separate deal with each little corp holder, giving the holder big corp stock in return for his little corp stock.
Plan of exchange: a little corp holder need not participate, in which case he continues to own a stake in little corp. However, some states allow little corp to enact a plan of exchange, under which all little corp shareholders are required to exchange their shares for big corp shares (the net result of this is like a statutory merger).
Stock for Assets Exchange
Big corp gives stock to little corp, and little corp transfers substantially all of its assets to big corp. Then, little corp dissolves, and distributes the big corp stock to its own shareholders.
The net result is virtually the same as a statutory merger.
Forward merger: acquirer creates a subsidiary for the purpose of the transaction. The subsidiary usually has no assets except shares of stock in the parent. The target is then merged into the acquirer's subsidiary.
- Rationale: this is very similar to a stock swap, except that all minority interests in little corp are automatically eliminated.
Reverse merger: same as forward merger, except the acquirer's subsidiary merges into the target, rather than the other way around.
- Advantages: reverse is better for stock swap because it automatically eliminates all little corp shareholders, which the stock swap does not. It is better than a simple merger because: (1) big does not assume all of little's liabilities, and (2) big's shareholders do not have to approve it. It is better than a forward merger because little survives as an entity, thus preserving contract rights and tax advantages better than if little were to disappear.
Sale Type Transaction
Transaction where little corp shareholders receive cash or bonds, rather than big corp stock, in return for their interest in little corp.
Types: (1) asset sale and liquidation, (2) stock sale
Asset Sale and Liquidation
Little corp's board approves a sale of all or substantially all of little's assets to big corp, and the proposed sale is approved by the majority of little's shareholders. Little conveys its assets to big, and little receives cash (or big corp debt) from big corp. Little usually then dissolves, and pay the cash or debt to its shareholders in proportion to their shareholdings in a liquidating distribution.
No corporate level transaction takes place on the little corp side. Instead, big corp buys stock from each little corp shareholder for cash or debt.
After big controls all or the majority of little corp's stock, it may but need not cause little to be: (1) dissolved, with its assets distributed to the various stockholders, or (2) merged into big corp, with the remaining little holders receiving big stock, cash, or debt.
Common form of stock sale, in which big corp publicly announces that it will buy all or the majority of shares offered to it by little corp shareholders (alternatively, big corp might privately negotiate purchases from some or all of littles shareholders).
A cash payment made by a corporation to its common shareholders pro rata. It is usually paid out of the current earnings of the corporation, and thus represents a partial distribution of profits.
The stockholder's permanent investment in the corporation.
If the stock has par value, stated capital is equal to the number of shares outstanding times the par value of each share.
Everything in the corporation's capital account other than stated capital.
Payment of Dividends
The decision to pay must be made by the board of directors.
A dividend may be paid if:
(1) payment of the dividend will not impair the corporation's stated capital; and
(2) payment will not render the corporation insolvent.
Earned Surplus Statutes
In most states there are earned surplus restrictions: dividends may be paid only out of the profits which the corporation has accumulated since its inception.
Impairment of Capital Statutes
Prohibits dividends that would impair the capital of the corporation.
Even if a dividend payment would not violate the applicable capital test, in nearly all states payment of a dividend is prohibited if it would leave the corporation insolvent.
Dividends paid out of the current earnings of the corporation, even though the corp otherwise would not be entitled to pay the dividends (because it has no earned surplus in an earned surplus state, or because payment would impair its stated capital in an impairment of capital state).
Occurs when the corporation buys back its own stock from stockholders. This may happen by open market repurchases, by a "self tender" (ie a tender offer by a public company offering to buy some number of shares pro rata from all shareholders), or by face to face selective purchases.
Equity vs Bankruptcy Meaning of Insolvent
Equity Insolvency: a corporation is insolvent if it is unable to pay its debts as they become due.
Bankruptcy Insolvency: a corporation is insolvent if the market value of its assets is less than its liabilities.
MBCA Insolvency Test
No dividend may be paid if it would leave the corp insolvent under either the equity or bankruptcy definition of insolvent.
If shares have a par value, the corporation may not sell the shares for less than this value. This protects both the corporation's creditors and also other shareholders.
Watered Stock Liability
If shares are issued for less than their par value, creditors will sometimes be allowed to recover against the stockholder who received the cheap stock.
Consideration for Issuance of Shares
Shares may be paid for not only in cash, but also by the contribution of property, or by the performance of past services.
States vary as to whether shares may be purchased and returned for promises to perform services or donate property (Delaware does not allow payment in the form of a promise to perform future services).
A right sometimes given to a corp's existing shareholders permitting them to maintain their percentage of ownership in the corp, by enabling them to buy a portion of any newly issued shares.
Includes ordinary stocks, bonds, investment contracts, and other devices.
Initial Public Offering (IPO)
1. Gives existing SHs liquidity.
2. Funds acquired by a corp can be used to make acquisitions of other companies.
3. Benefit of enabling a company to better compete for employees.
4. Preferred by prospective employees since they are better known.
5. Disclosure: there is a great amount of disclosure (this is viewed as a negative).
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