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CA Bar 2009: Corporations

QUESTIONS CORPORATIONS

What are the 6 major test issues? 6 Major Test Issues


1. Corporate formation
2. Issuance of stock
3. Action by and liability of directors and officers
4. Rights of shareholders
5. Fundamental corporate changes
6. Federal securities laws

Part 1: Corporate Formation


What’s a promoter? A. Pre-Incorporation Contracts: Promoters and Subscribers
1. Promoter: are persons acting on behalf of a corporation not yet formed
When does the corporation a. Rule:
become liable for the promoter’s 1) Step 1: the corporation becomes liable for the promoter’s pre-
pre-corp K? incorporation contract when the corporation adopts the K by either
A) express board of directors resolution, or
What happens if the PIK is B) implied adoption by knowledge of the K and acceptance of its benefits
entered into but no corp is
formed? 2) Step 2: The promoter retain liability on pre-incorporation K’s until there
has been novation, ie an agreement b/t the promoter, corp and the other
What happens if there’s no contracting party that the corporation will replace the promoter under the
novation? K.
b. If corporation is never formed, then the promoter alone is liable on the K.
When can a promoter sell c. If promoter ends a PIK, and the corp merely adopts the K  upon adoption,
property to the corp? the corp is liable on the K but promoters still retain liability until novation.
d. Promoters are fiduciaries of each other and of the corp, thus they cannot make
What happens if promoter sells a secret profit.
property acquired after being a 1) Sale to corporation of property acquired by promoter before becoming a
promoter, to the corp? promoter  can only sell to corp for fair market value
2) Sale to corporation of property acquired by promoter after becoming a
Can an offeror revoke an offer to promoter  any and all profit is recoverable by the corp; corp can
buy stocks pre-incorporation? disgorge all profits made by the promoter even if property was sold to the
corp for fair market value
2. Subscriber: persons or entities who make a written offer to buy stocks from a
corporation not yet formed
a. Q: after signing the subscription agreement offering to buy stocks, can the
What’s an incorporator? offeror revoke her offer to buy stock in the corporation not yet formed? The
offer is irrevocable for a 6 month period.
What must the AoI contain? B. Formation Requirements—De Jure Corporate States
1. Incorporator: merely signs and files the articles of incorporation w/ the state
What is presumed about the 2. Articles of Incorporation: must contain: APAIN
purpose clause? a. # Authorized shares (the maximum number of shares – corporation cannot
issue more than this number w/o amending the AoI)
If narrow purpose and corp goes b. Purpose clause
beyond that scope into ultra vires 1) Corp’s express statement of general purpose and perpetual duration is ok
activity? 2) In absence of such 2 statements: gen purpose + perpetual duration
presumed
What is the agent? 3) Narrow purpose and ultra vires activities
A) Tip: what if you have a narrow purpose clause and then you engage in
What must the name of corp an ultra vires activity?
have? (1) The state can enjoin the ultra vires activity.
(2) Corporation may sue its own directors/officers for losses caused
How can a corp be a de facto by the ultra vires activity.
corporation? c. Agent: and address of registered office (registered agent = corp’s legal rep who
can receive notice and process)
d. Incorporators and addresses
e. Name of Corporation: must contain indicia of corporate status
3. By-laws: need not even exist—need not be in the AoI
C. De Facto Corporation Doctrine
1. Not a pure de jure corporation but can be a de facto corporation.
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CA Bar 2009: Corporations
What’s the cardinal rule of 2. Rule: if organizers have made a good faith, colorable attempt to comply w/
corporation liability? corporate formalities and have no knowledge of the lack of corporate status  can
be a de facto corp
Why would a court allow a V to D. Legal Significance of Formation of Corp
pierce the corporate veil? 1. Corporation is a separate legal person
2. Cardinal Rule: Generally, shareholders are not personally liable for the debts of
What are the two piercing the corporations. This is the principle of limited liability, which means that they
corporate veil theories? shareholders are liable only for the price of their stocks.
How can a foreign corp engage in E. Piercing the Corporate Veil (Equity Doctrine)
intrastate biz? 1. Rule: generally, shareholders are not liable for the debts of a corporation
2. Issue: can shareholders be held liable for third party tort/K victims? Yes, if the
court is willing to pierce the corporate veil to avoid fraud or unfairness and to
render that shareholder to the third party V
3. When can the veil be pierced?
a. Alter Ego Rule: the owners have failed to maintain sufficient corporate
formalities and have treated the corp as their alter ego
1) Ie, commingling personal and corporate funds can lead to
undercapitalization
b. Undercapitalization: failure to maintain sufficient funds to cover foreseeable
liabilities
4. Innocent third party tort V are more likely to get piercing than K victims. Pierce
the veil against the controlling shareholder.
F. Foreign Corporations: Outside of the Forum State
1. Foreign corporations, incorporated in another state, but wants to engage in regular
intrastate biz must qualify by filing a certificate of authority w/ the Secretary of
What is proper consideration for a State including all requirements of the Articles of Incorporation.
corp issuing its own stock?
Part 2: Issuance of Stock by the Corporation
What is treasury stock? A. Consideration
1. How much value can the corp receive for selling its own stock?
Can a corp use par value stocks to 2. Par Value: minimum issuance price  corporation can never receive less than the
buy property? par value as consideration (# of Stocks * par value)
What happens if stock is issued 3. No par: no minimum issuance price—is valid
for less than par value? 4. Treasury Stock:stock that in the past, was previously issued by the corp and has
since that time been repurchased or reacquired and corp wants to re-sell its treasury
stock. Treasury stock is like no par, thus any valid consideration deemed adequate
by the Board is proper consideration.
5. Can you use par value stock to buy property? Yes: any valid consideration may be
received for the stocks if Board values the property for at least the par value of the
stocks.
6. If stock is issued for less than par value:
a. Directors, who have the authority to issue stocks, can be held personally liable
What are preemptive rights? b/c they don’t have the authority to do a below par issuance
b. The shareholder who bought the below-par stock can held liable
What if you can’t tell whether c. Corporation can elect to sue either the directors or the shareholder but not both.
there are preemptive rights? B. Preemptive Rights
1. Def: the right of an existing shareholder to maintain her percentage of ownership
by buying stock whenever there is a new issuance of stock for cash
What are the 4 statutory 2. Default rule: preemptive rights do not exist unless they are expressly granted in the
requirements of directors? Articles
What is necessary for a valid Part 3: Action by and Liability of Directors and Officers
Board meeting? A. Statutory requirements of Directors
1. Corporations must have a Board w/ at least 1 member
2. Shareholders elect directors
3. Shareholders can remove a director before his term expires on the basis of cause or
without cause.
4. Valid meeting
a. Unless all directors consent in writing to act w/o a meeting, a meeting is
required
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CA Bar 2009: Corporations
b. Notice of directors’ meetings can be set in bylaws
c. Proxies for board voting are not allowed. Also no voting agreements but
conferences are generally valid.
d. Quorum: must have a majority of all directors to take an action unless bylaws
specify otherwise
What are the areas of liability of e. Vote: to pass a resolution, must pass by a majority vote of those present
directors for DoC? f. Each director is presumed to have concurred in Board activities unless her
dissent or abstention is recorded in writing, ie minutes or letter to corp
secretary
B. Liability of Directors to their Own Corporation and Shareholders
1. Directors have a duty to manage the corp though they can delegate management
functions to a committee of directors who make recommendations
2. Biz Judgment Rule: directors not liable for innocent mistakes; presumption that
directors are managing in good faith
What are the types of violations of 3. Fiduciary Duties: directors owe duties of care and loyalty
the DoL? 4. Duty of Care: director must act w/ the care that a prudent person would use in
running his own biz unless the Articles have limited director liability for a breach of
the DoC
5. Duty of Loyalty: directors may not receive an unfair benefit to the detriment of the
corp/shareholders unless there has been disclosure of all material facts and
independent ratification
a. Self Dealing: a director who receives an unfair benefit in a txn w/ their own
corporation (or another one of her businesses, or a familial interest etc.)
b. Usurping corporate ops
c. Ratification: can absolve that director of liability:
1) Majority vote of independent directors
2) Majority vote of a committee of at least 2 independent directors, or
3) Majority vote of shares held by independent shareholders
6. Essay Analysis:
What are the 4 officer duties? a. Dir have a duty to manage.
b. They are protected by the BJR.
c. But they are fiduciaries and thus owe a DoL and DoC.
d. DoL: self dealing/usurpation/ratification
What are the 3 indemnification C. Officers
rules? 1. Owe same duty of care and loyalty as directors
2. Are agents of the corp and bind the corp by their authorized activities
What are the 4 routes to 3. Must have a Prez, Secretary and Treasurer
permissive indemnity? 4. Have virtually unlimited power to select officers and can remove at any time—but
the corp will be liable for breach of K damages
D. Indemnification of Directors and Officers
1. If Dir/Officer has incurred costs, attorney’s fees, fines, judgments or settlements in
the course of corp biz, and he seeks reimbursement:
a. Never repay dir: if he has lost a lawsuit to his own corp
b. Always repay dir: if he has won a lawsuit against any party (incl. corp itself)
c. May repay dir if:
1) Liability to third-parties or settlement w/ corporation
2) Dir shows that he acted in good faith and believed that conduct was in
corp’s best interest
3) Who decides whether to grant permissive indemnity?
A) If a majority of independent directors approves
What are the requirements for B) If a committee of at least 2 independent directors approves
standing for a derivative suit? C) If a majority of shares held by independent shareholder vote for it
D) A special lawyer’s opinion could recommend it

Part 4: Rights of Shareholders


A. Shareholder Derivative Suits
1. To enforce the corp’s cause of action (always ask if the corp could’ve brought the
Which stockholders vote? suit, if so it’s derivative)
2. Requirements of a derivative suit:
a. Contemporaneous stock ownership—at least 1 stock owned when claim arose
and throughout entire litigation
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CA Bar 2009: Corporations
b. Demand: ask Board to sue first and get rejection or 90 days have passed since
demand was made  then sue
What is required for a valid B. Voting
proxy? 1. Only the record date owner of stock votes. (record date = voter eligibility cutoff
date set by the Board, a day falling w/in the 70 day period before meeting day)
a. Thus you can own shares on the record date, sell later, but retain the right to
vote b/c you were a record date owner.
Can proxies be revoked? 2. Voting by Proxy
a. Valid proxy requires:
Where do shareholders vote? 1) Writing: fax/email is ok
2) Signed by the record owner
What are the steps at the meeting 3) Directed to Secretary of Corp
to vote? 4) Authorizing another to vote your shares
5) Valid only for 11 months
What are the 2 ways to pool b. Proxies are revocable unless they are labeled irrevocable and coupled w/ an
votes? interest (ie the proxy holder owns the shares after record date)
c. Where do shareholders vote?
1) Properly noticed (time and place) annual meeting where at least 1 director
slot is open for election
2) Specially noticed meeting (called by the Board, Prez or by holders of 10%
of voting shares) called to vote on fundamental corp changes or on
proposals.
A) Notice must describe special purpose of meeting and can’t do
anything that’s not in the notice
d. Steps at the meeting:
1) Quorum: a majority of all shares must be represented when meeting starts
2) Vote: votes cast in favor must exceed votes cast against
e. Pooled or Block Voting:
1) Voting Trust: formal delegating of voting power to a voting trustee for 10
years
A) Written trust agreement
What is straight voting? B) Typically filed w/ corp
C) Transfer shares to voting trustee
What’s cumulative voting? D) Shareholders get trust certificates
E) Shareholders retain all other rights except for voting
What’s the default rule for F) Duration: generally 10 years unless extended by agreement
choosing among the two? 2) Agreement: in writing, to vote shares as required by the agreement
f. Cumulative voting for Directors
1) Traditional, straight voting: 1 share = 1 vote per election, and each open
slot is a separate election
2) Cumulative voting: multiply the number of shares by the number of open
When can’t dividends be issued? slots = total number of votes, but only one election no matter the number
of open slots
What is the order of priority? 3) Default rule: cumulative voting doesn’t exist unless it is expressly granted
in the AoI
C. Right of Shareholder to examine the books and records of corporation—any shareholder
shall have access upon notice and at proper times
D. Dividends – brutal in CA
1. Shareholders have no right to receive dividends at all. BoD has almost total
discretion to decide whether or not to declare dividends.
2. Rule: but Board cannot declare dividends if corp is insolvent or rendering dividends
would render corp insolvent.
a. If they do that, Board members become personally liable for unlawful
dividends.
What are the steps to eliminating b. Board defense: good faith reliance
corp formalities? 3. Types of shares:
a. Common shares: paid last, and paid equally
b. Preferred: pay these shares first
c. Participating: get paid twice, once as participating and once as common
d. Cumulative: have the right to be paid prior years’ payments + this year’s
E. Shareholder Agreements to Eliminate Corporate Formalities (Closely-Held Corps)
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CA Bar 2009: Corporations
1.Step 1: unanimous shareholder election to eliminate in writing, and
What are the elements of a PC? 2.Step 2: some reasonable share transfer restriction
3.Upsides:
a. No piercing even if you fail to observe formalities
b. Possible Subchapter S Corp status
1) S Corps are deemed partnerships for tax purposes
2) S Corp: up to 100 shareholders and only 1 class of stock
F. Professional Corporation
1. Licensed profs may incorporate as a PC, containing only 1 profession
2. Requirements:
When can shareholders be held a. Organize and file Articles designating themselves as a PC
liable? b. Shareholders may be licensed professionals
c. May practice only 1 profession
d. Liable for personal malpractice
e. But not liable for each other’s malpractice or obligations of the corp itself
G. Shareholder Liabilities
1. Generally, shareholders not liable for corp obligations
2. Exceptions:
a. Piercing corp veil
b. Controlling shareholders owe a fiduciary duty of care to minority shareholders
What are the recognized c. Controlling shareholders are liable for selling corp to a party who loots the
fundamental changes? corp, unless reasonable measures were taken to investigate the buyer’s rep and
plans for the corp
What are the procedural steps to
getting an FC? (5) Part 5: Fundamental Corporate Changes
A. Recognized fundamental changes:
When can the Board engage in a 1. Merger, Consolidation and Dissolution
type of merger? 2. Fundamental (not ministerial) amendment (ie increasing stocks) of the Articles or
sale (not purchase) of substantially all of the corp’s assets
How does a dissenter perfect his B. Procedural Steps:
right of appraisal? 1. Board resolves to change at a valid meeting
2. Notice of special meeting
3. Approval by a majority of all shares entitled to vote (not just quorum) and by a
majority of each voting group that is adversely affected by the change
a. Exception: no shareholder approval is required for a “short form” merger
where a parent corp that owns 90%+ of the stock in its subsidiary merges w/
the subsidiary—can be done by the Board
4. Possibility of dissenting shareholder right of appraisal
a. A shareholder who doesn’t vote for the FC has the right to force the
corporation to buy her shares at fair value
b. To perfect this right:
1) Before vote itself, dissenter has to file objection
What are the elements of a 10(b) 2) At vote, cannot vote for the change (either abstain or reject)
action? 3) Make prompt demand to be bought out after vote
c. What if you can’t agree on fair value? A court has the power to appoint an
expert appraiser to value the shares and appraisal will be binding on the parties.
5. Must file notice w/ the state, ie Articles of Merger

Part 6: Fed Securities Laws Considerations


A. Section 10(b) of the’34 Act
1. It’s the General Anti-Fraud provision of the securities laws
2. Elements of a 10(b) Action:
a. Scienter: intent to deceive
b. Deception:
1) Liar: misrepresent a material fact or failure to disclose material facts in
breach of their fid duty to disclose
2) Insider trading
A) Misappropriate: steals, converts, material nonpublic info and uses it to
purchase or sell securities
B) Tippers: one who tips inside info for personal benefit to another and
trades on it

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CA Bar 2009: Corporations
C) Tippees: those who receive inside info and trade on it w/ the
knowledge that the info was disclosed in breach of the tipper’s fid
duty
What are the requirements of c. Affirmative act: in connection w/ the actual purpose or sale of securities not
16(b)? refraining from buying/selling
What happens when 16(b) 3. Private action for damages, investors must also prove:
applies? a. Reliance on the fraud or bought at a price infected by the fraud (fraud on the
market)
b. Loss causation: fraud not only induced the purchase or sale but also caused
their economic losses
B. Section 16(b) of the ’34 Act: Short Swing Trading Profits
1. Only applies to:
a. Big corps that report:
1) Listed on a national exchange
2) At least 500 shareholders and 10M in assets
b. Big shot D—officer/director ore more than 10% shareholder
c. Type of txn: no buying or selling stock w/in a single 6 month period (short
swing trading)
2. When 16(b) applies:
a. All profits from such short swing trading are recoverable by the corporation,
b. If w/in 6 months, before or after any sale, there was a purchase at a lower
price than the sale price, there is a profit.
C. SOX
1. Applies to reporting companies
2. CEO and CFO must certify that based on the officer’s knowledge, reports filed w/
the SEC:
a. Do not contain material misrepresentations or omissions, and
b. Fairly presents the financial position of the company
3. Willfully certifying a false report could bring $5M fine and 20 year jail sentence
4. If false reports have to be restated, the corp (directly or derivatively) may recover
Officer’s profits made from trading the company’s securities w/in the 12 months
after the false reports were filed and may receive incentive based comp received in
that period.