15 Corporations Quiz

Front 1

What is a promoter?

 

How is the promoter compensated?

Back 1

A. PROMOTERS AND PRE-INCORPORATION CONTRACTS 
• Promoter: someone who takes action on behalf of a corporation before the corporation is formed 
• The pre-incorporation services provided by a promoter constitute valid consideration for shares of the corporation’s stock. 

 

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Who is liable for pre-corp contracts?

 

Exceptions?

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1. Pre-incorporation contracts: contracts entered into on behalf of a corporation that has yet to be formed. Promoters are personally liable for pre-incorporation contracts, subject to two exceptions. 

2.  If the third party to the contract knows that the corporation does not yet exist but 
nonetheless agrees to look solely to the corporation, once formed, for performance, then the promoter is off the hook. The promoter has the burden of proof with respect to this exception. 
 Once the corporation is formed, it may enter into a novation with the third party to the contract. If it does so, the promoter is off the hook.

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What is a novation?

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o Novation: a new contract with the exact same terms as the original contract, but the promoter is replaced by the corporation as a party 
to the contract. The third party is under no obligation to agree to a novation. 

 

Front 4

What is a corporation’s Liability for Pre-Incorporation Contracts?

 

Is the promoter the corporation's agent?

Back 4

A corporation, once formed, is is not automatically liable for pre-

incorporation contracts and need not adopt them (although it certainly may). Indeed, a 
promoter can’t be a legal agent for a non-existent principal.

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What is the exception to the rule regarding a corporation's liability for pre-incorporation contracts?

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b. Exception—liability when contract “adopted” 
 The corporation, once formed, becomes liable for a pre-incorporation contract if it 
adopts it. Adoption can be express or implied.

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What is express adoption?

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 Express adoption occurs when the corporation’s board of directors takes 
formal action to adopt the contract. 

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What is applied adoption?

 

Can a corporation enforce an adopted contract?

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 Implied adoption occurs when the corporation, with full knowledge of the contract’s existence, accepts the benefits that contract. 

 Once a corporation adopts a contract (and thus becomes liable for it), it can fully 
enforce that contract against the third party. 

 

Front 8

Once a corporation adopts a pre-incorporation contract, is the promoter off the hook?

 

How does a promoter get off the hook?

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c. Promoter and corporation liable until novation 
 When a corporation adopts a pre-incorporation contract, the promoter is not off the hook. Instead, both the promoter and the corporation are on the hook. 
 To get the promoter off the hook, the corporation and the third party must enter into a novation, which the third party is under no obligation to do. 

 

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Example 1: (Summer, 2006 Bar Exam): Steve was looking to purchase a custom window and contacted John, a local craftsman. John told Steve that he was in the process of forming a corporation. John then entered into a contract for the window with Steve, signing “John, for Hand-Crafted Windows.” John 
completed the window and installed it in June. In July, Steve issued John a check made out to “Hand-Crafted Windows, Inc.”, as John had requested. John then incorporated the corporation and deposited the check in the corporation’s newly-established checking account. When the window installed by John began to leak profusely, Steve sought to hold both John and the corporation responsible for the faulty window. 

 

Back 9

John was a promoter when the contract was entered into because the corporation hadn’t been formed. Because a novation between Steve and the corporation was not entered into after the corporation was formed, John is 
liable on that contract. However, the corporation is also liable on the contract, 
as it impliedly adopted the contract. It did so when it knowingly accepted the benefits of that contract when the check was deposited into its bank account. 

 

Front 10

What is an incorporator?

What are the duties and requirements?

What is the liability?

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B. INCORPORATION 
1. Procedure 

o In order to form a corporation, one or more “incorporators” will prepare and sign a document called the “certificate of incorporation.” 
They will then deliver the certificate to New York’s Department of State for filing.

o Any natural person can be an incorporator, so long as they are over the age of 18. In practice, an incorporator is typically the promoter of the corporation or an attorney hired to incorporate the business. 

o An "incorporator" incurs NO liability simply because he is the one to sign and deliver the certificate of incorporation to the state.  Nor is he responsible for pre-incorporation contracts entered into by a promoter (unless, of course, he is the promoter).

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What must be included in a certificate of incorporation?

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2. Contents of the Certificate of Incorporation 
A certificate of incorporation must include certain things, cannot include certain other things, 
and may optionally include still others. 
a. “Musts” 
1) Corporate name 
• The certificate must include your corporation’s name. That name 
must be distinguishable from the names of other existing New York corporations, or 
your filing will be rejected. 
• Moreover, to alert the public that they are dealing with a limited liability entity, your 
corporate name must include the word “corp,” 
“Inc,” “LTD,” or an abbreviation thereof. 

 

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Corporate purpose:  generic vs. specific

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2) Corporate purpose 
• The certificate must include a statement of the corporation’s purpose. While the 
purpose may be specific, it can also be “generic”. Most certificates have a “generic” 
purpose as it affords maximum operational flexibility. 
• Example of specific purpose: “The purpose of this corporation is to bake and sell cupcakes.” If the corporation does more than this, it may be exceeding its stated purpose. 
• Example of generic purpose: “The purpose of this corporation is to engage in any 
activity lawful under the laws of the State of New York.” 

 

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limited duration vs. perpetual existence

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3) Corporate duration 
• If the corporation is to have a limited duration (i.e., lifespan, such as 40 years), that 
limited duration must be stated in the certificate. 
• Corporations with certificates that don’t specify a limited duration are deemed to 
have perpetual existence. 

 

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corporate address/location

 

Why is this needed in the cert of inc?

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4) Office of corporation and registered agent 
• If the corporation will have an office in New York, then the county in which the office of the corporation is to be located must be stated in the certificate. 
• If the corporation won’t have an office in New York, it needs to have a registered agent with a New York address listed in the 
certificate. In addition, you need to include a statement that the registered agent is the agent of the corporation upon whom process against it may be served. 

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requirement to describe the stock of the corp:

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5) Authorized shares 
• The certificate must set forth the aggregate number of shares of stock that the corporation has the authority to issue and the par value, 
if any, of those shares. 
• If desired, shares can be divided into two or more classes, such as common stock and preferred stock. If the shares are divided into classes, the designation of each class and a statement of the relative rights, preferences, and limitations of its shares must be stated. In other words, you have to state in your 
certificate how each class differs from the other class or classes. 
Note 1: Sophisticated publicly traded companies, such as IBM, typically have 
complex capital structures featuring multiple classes of stock. Closely-held “mom and pop” corporations typically have only one class of stock, namely common stock. 

 

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requirements regarding service of process:

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6) Secretary of state designation 
• The certificate must designate the New York Secretary of State as the corporation’s agent to receive service of process against the corporation. 
• It must also include an address to which the Secretary of State can send a copy of 
any process it receives

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Prohibitions on the cert of incorp:

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b. “Cannots” 
 Your corporation’s name cannot include certain words or phrases, such as “state 
police,” “chamber of commerce” and “board of trade.” 
 Additionally, your corporation’s name cannot include certain words such as “bank,” 
“savings,” “insurance,” and “title” without the permission of the New York Superintendent of Banks or the New York Superintendent of Insurance, as appropriate. 

 

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Optional things you may include in the cert of incorp-

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c. “Mays” 
1) Corporate powers 
In addition to specifying a corporate purpose, the certificate of incorporation may 
enumerate powers that the corporation possesses. However, this generally isn’t 
necessary because the BCL gives New York corporations a litany of implied general powers. 
Example 2: The power to make contracts, to lend and invest its funds, to make charitable donations and to be a partner in another business entity. 
2) Exculpatory charter provision 
• The certificate may set forth a provision absolving the corporation’s 
directors from personal liability for negligent business decisions they may make. This provision is referred to as an “exculpatory charter provision”.

• Such a provision does not protect directors with respect to actions they take that are in bad faith, illegal or done for an improper personal benefit. 
3) Other provisions 
A certificate may include any other provision so long as that provision is legal and 
relates to the corporation’s business or affairs. 

 

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What happens at the first meeting?

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3. Organizational Meeting 
o Once the certificate has been filed, the incorporator will hold an organizational meeting. 
o At this meeting, the incorporator will adopt the corporation’s initial bylaws and appoint the initial directors to the board who will hold office until the first annual meeting of shareholders. 

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What is a de jure corporation?

 

What is evidence of a de jure corp?

 

What is the main benefit of a de jure corp?

 

What is the exception to limited liability?

Back 20

1. Effect of Proper Incorporation—”De Jure” Corporation 
o Once all of the statutory requirements for incorporation have been satisfied, a de jure 
corporation is created. A de jure corporation is one properly formed under the law. 
o A certificate of incorporation that is received by the Department of State and then filed by 
the Department represents conclusive evidence of proper, “de jure” incorporation. 
o The main benefit of forming a de jure corporation is limited liability. The 
corporation itself—and not persons associated with the corporation (namely, shareholders, directors, officers, and other employees)—is liable for activities undertaken by it. 
o Shareholders can lose their investment if the corporation fails, but no more than that. Indeed, creditors cannot go after the personal assets of shareholders if the corporation does not have the money to pay them back. Of course, the one exception to limited liability is “veil piercing,” which we will discuss in just a moment. 

 

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bad faith defective incorporation

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2. Defective Incorporation 
a. Lack of good faith effort to incorporate 
If you conduct your business as if it were a corporation without first making a 
good faith attempt to comply with the statutory incorporation requirements, then you are considered to be a promoter and, as such, are personally liable for any obligations incurred in the name of the nonexistent corporation. 

 

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good faith defective incorporation

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b. Good faith effort to incorporate–”de facto” corporation 
 However, if you make an unsuccessful effort to comply with the incorporation 
requirements, you may be able to escape from personal liability under the de facto 
corporation doctrine. 
 Three requirements must be met to achieve “de facto” corporate status: 
• The owner must make a good faith effort to comply with the statutory incorporation requirements; 
Note 2: At a minimum, this means the owner must prepare and sign a certificate of incorporation and then attempt to deliver it to the Department of State for filing. 
• The owner must operate the business as if it were a corporation; and 
• The owner must not know that the incorporation requirements have 
not been me.

If the owner meets the requirements of “de facto corporate status,” then the business 
entity is treated as a de facto corporation and the owner, as a de facto shareholder, is 
not personally liable for obligations incurred in the purported corporation’s name. 

 

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NY distinction regarding "corporation by estoppel":

Back 23

c. Corporation by estoppel not recognized 
New York does not recognize the “corporation by estoppel” doctrine. 
Thus, a person who deals with a business thinking it is a corporation will not be estopped for that reason alone from suing the business owner personally if de jure or de facto status has not been achieved.

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When do courts pierce the corp veil?

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B. PIERCING THE CORPORATE VEIL 
• In New York, the limited liability ordinarily protecting the personal assets of corporate 
shareholders will be disregarded if necessary “to prevent fraud or illegality or to achieve justice.” This is referred to as “piercing the corporate veil”. 
• When veil piercing occurs, the shareholders’ personal assets are exposed to the 
claims of the corporation’s creditors. 
• There is no single test the court uses in determining whether or not to “pierce the corporate veil.” Rather, it considers a number of contributing factors. 

 

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Factors courts use to pierce the veil:

1.  excessive domination

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• The more factors that exist, the more likely it is that a court will pierce a corporation’s veil. The 
factors are: 
o Excessive domination of the corporation by its shareholders. Here, the shareholders treat the corporation as a puppet with the shareholders being the puppeteer. 
Excessive domination also occurs when the shareholder is a parent corporation, and the 
corporation in question is its subsidiary; 
Exam Tip 1: You may see a fact pattern in which the parent corporation exercises such excessive direction and control over its subsidiary that the subsidiary has no real identity of its own. 

 

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2.  personal gain-

3.  illegality or fraud

4.  lack of corporate formalities

 

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2.  Shareholders are carrying on the business for personal gain rather than 
corporate gain; 

3.  the corporation is being used to hide illegal activities or perpetuate a 
fraud; 
4. Corporate formalities are largely or completely disregarded. In this 
regard, look for the following: 
 Failure to issue stock certificates to shareholders; 
 Failure to hold annual shareholder meetings; 
 Failure to elect directors to the board; 
 Failure to hold meetings of the board; 
 Failure to document, through board of director resolutions, major corporate decisions.

 The corporation is inadequately capitalized. In other words, the amount of money the shareholders have invested in the corporation is “trifling” compared to the business to be done and the associated risks

Front 27

What is an ultra vires action?  

 

ARe these common?

 

What remedy?

Back 27

C. ULTRA VIRES ACTIONS 
• An “ultra vires” action is an action that the corporation lacks the power to engage 
in. Historically, when a corporation engaged in an ultra vires action that backfired, it would try to avoid liability by arguing that it lacked the power to engage in the action in the first place. 
• The powers of a corporation are found in two places. As noted earlier, a corporation’s explicit powers may be set forth in its certificate of incorporation. However, a litany of other general powers are impliedly given to the corporation by the BCL itself. So, today, few activities are “beyond the power” of a corporation. 
• Nevertheless, if a corporation does engage in an ultra vires action, a shareholder or the 
state can initiate a proceeding against the corporation to enjoin the action. In 
addition, the corporation can take action against a director, officer, or employee of the 
corporation who engages in such action.

Front 28

What are the three major corporate instruments/documents?

 

Certificate of incorporation:

Back 28

D. INSTRUMENTS OF GOVERANCE 
Three corporate instruments control the governance of a corporation. They are the certificate of incorporation, the by-laws and board of directors’ resolutions. 
1. Certificate of Incorporation 
A certificate of incorporation must be filed in order to incorporate a business. Many certificates contain provisions that impact on corporate governance; others contain few if any governance provisions. 

 

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How do you amend the cert of inc?

 

Certificate of correction vs certificate of amendment:

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How do you amend your certificate? 
a. Certificate of correction 
 Any minor errors or inaccuracies in the certificate can be corrected without 
obtaining shareholder approval by simply filing a certificate of correction with the state. 
 You cannot change the corporation’s name through a certificate of 
correction. b. Amendment of certificate 
 A corporation must file a certificate of amendment to make more significant changes to its certificate of incorporation (e.g., a name change). The certificate of amendment will 
identify each provision of the certificate which is to be amended or eliminated and the 
full text of the provision or provisions, if any, which are to be substituted or added. 
 If the corporation does not yet have shareholders or subscribers contractually 
obligated to purchase shares, the amendment can be filed by the incorporator.

 However, if the corporation does have existing shareholders, then holders of 
a majority of all outstanding shares entitled to vote must approve the amendment before the amendment is filed. The certificate may contain a higher voting threshold (such as a “supermajority vote” of shareholders).

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Second important corp instrument:

 

What is typically included in the by-laws?

Back 30

2. By-Laws 
By-laws of a corporation may contain any provision relating to the business of the corporation 
and the conduct of its affairs. Traditionally, by-laws mainly discuss mechanical and logistical 
matters, such as: 
 Details about shareholder meetings and board of director meetings, including the giving of notice relating to those meetings and the quorum and voting requirements for those meetings; 
 The number of directors that the board will have and how vacancies on the board will be filled; 
 The types of committees that the board may form; and 
 The types of officers (e.g., president, vice president) the corporation may have.

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Initial bylaws and amending bylaws:

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a. Initial by-laws 
The initial by-laws of a corporation are adopted by its incorporator at the organizational meeting. Thereafter, the by-laws will be approved by the board of directors at its initial 
board of directors meeting. 
b. Amending the by-laws 
 The shareholders always have the power to adopt, amend, or repeal any or all of the by-laws through a majority vote. 
 Additionally, the shareholders can share the power to amend the by-laws with the 
board of directors, but only if a provision to that effect is inserted into the certificate of incorporation. 
 However, shareholders may amend or repeal any board-adopted by-law, because 
shareholders always have the last word on the by-laws.   IMPORTANT

c. Shareholders knowledge of by-laws 
When you buy shares of a corporation, and thus become a shareholder, you are presumed to have knowledge of the by-laws and their legal effect. 

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Third major instrument of a corp:

Back 32

3. Board of Directors’ Resolutions 
Another source of governance is found in the resolutions of the board of directors. These 
resolutions represent the written record of the board’s “resolve” that the corporation take certain action, and thus provide a nice “paper trail” of the corporation’s authority to engage in certain actions. 

Example 3: “Resolved that it is in the best interests of the corporation to hire Hillary Maguire as the corporation’s chief executive officer.” 

 

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What is the order of priority of each of the major corporate instruments?

Back 33

4. Order of Importance 
If there is a conflict between a corporation’s certificate of incorporation, by-laws and/or board resolutions, the certificate of incorporation takes priority followed by the 
by-laws. 
Example 4: (Summer, 2010 Bar Exam): ABC, Inc.’s certificate of incorporation specified that a vote of the holders of two-thirds of the outstanding shares of common stock was necessary to approve a shareholder’s proposal. ABC, Inc.’s by-laws, however, required a unanimous shareholder vote. Because the certificate takes priority over the by-laws, the vote specified therein is the 
required vote.

Front 34

The two types of shareholder meetings:

 

Annual meeting:

 

Primary purpose of the annual meeting:

 

Failure to hold a meeting - what result?

Back 34

There are two primary types of shareholder meetings—annual and special. In addition, if 
necessary a special meeting specifically for the election of directors may be held. 
a. Annual Meeting 
 A corporation is required to hold an annual shareholder meeting each year on a date 
specified in the bylaws. 
 The primary purpose of the annual meeting is to elect directors, but any business that requires shareholder approval can also be addressed. 
 The failure to hold the annual meeting does not affect the existence of the corporation 
or invalidate any business conducted by the corporation. 
 A shareholder may seek a court order compelling the corporation to hold an annual meeting if it refuses to do so. 

 

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Special meetings:

 

Purpose of special meetings?

 

When must the board call a special meeting?

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b. Special Meeting 
 Shareholder meetings occurring between annual meetings are referred to as special 
meetings. 
 A special meeting may be called by the board or by anyone so authorized by the 
certificate of incorporation or by-laws. 
 Special meetings address issues that can’t wait until the next annual meeting. 
c. Special Meeting for the Election of Directors 
The board must call a “special meeting for the election of directors” when a failure to elect 
a sufficient number of directors to the board has occurred. 

 

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What can take the place of a meeting?

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Action by Written Consent 
Instead of holding a shareholder meeting (and thus avoiding the expense and delay  associated with such a meeting), shareholders may take any action by unanimous 
written consent, so long as the action they consent to could have been taken at an actual shareholder meeting. 
Note 3: The number of required shareholder consents may be reduced by a provision in the certificate of incorporation. For example, many certificates provide that consents from those holding a majority of all outstanding shares is 
all that is required (rather than unanimity). 

 

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Where are shareholder meetings generally held?

Back 37

2. MEETING LOCATION 
Shareholder meetings are generally held at a location specified in the bylaws or if there is no fixed place, at the “office of the corporation” in New York. 

Front 38

Notice of shareholder meetings (what rule)?

 

What must be included in the notice?  What if it's a special meeting?

 

Result of failure to give notice?

Back 38

3. NOTICE OF MEETING 
o Shareholders must receive notice of an upcoming shareholder meeting in accordance with the “60-10 rule”. That is, written notice of a meeting must be given to shareholders no 
more than 60, nor less than 10 days before the meeting date. 
o The notice must include the time, date, and place of the meeting. If the meeting is a 
special meeting, the notice must state the identity of the person calling the meeting and the purpose of the special meeting, and only that business may be conducted during the special meeting. 
o Any shareholder who didn’t receive notice of a meeting may legally waive notice of the 
meeting either in writing or by simply attending the meeting. Otherwise, failure to give notice renders actions taken at the meeting, including elections, 
void. 

 

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Why is a record date selected?  

 

Who may vote?

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4. VOTING REQUIREMENTS 
a. Voting Eligibility/Record Date 
Because shares of stock in a corporation (particularly a publicly-traded corporation) change hands, a board will select a record date for an upcoming shareholder meeting. 
Only shareholders of record at the close of business on the record date will be entitled to 
attend and vote at an upcoming shareholder meeting. 
Example 5: (Summer, 2010 Bar Exam): Amy owned 50 shares in Sammie Corp. on November 30, which was the record date selected by Sammie Corp.’s board 
for a shareholder meeting scheduled for December 20. On December 12, Amy 
sold her 50 shares to Jim. Despite the fact that Jim is now the owner of the shares, Amy—and NOT Jim—gets to vote at the shareholder meeting held on December 20. 

 

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When may persons who are not a record owner of shares?

Back 40

1) Special ownership issues 
A person who is not a record owner of shares may nevertheless be entitled to vote. 
a) Beneficial owners of shares in publicly traded corporations 
o Investors holding shares in publicly traded corporations typically do so in “street 
name” (with “street” referring to Wall Street). This means they hold their shares in a brokerage account established with a broker-dealer, such as Merrill Lynch or E*Trade. 
o In that event, the broker-dealer is technically the “record” owner of the shares while the investor is the “beneficial owner” of the shares. 
As the beneficial owner of shares, you are entitled to direct your broker-dealer on how to vote your shares on your behalf. 

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What other persons who are not record owners may vote?

 

What about trustees?  Can they vote the shares?

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b) Fiduciaries other than trustees 
Shares held by a receiver, administrator, executor, guardian, conservator or other 
fiduciary, except a trustee, may be voted by him, either in person or by proxy, 
without transfer of such shares into his name. 
c) Trustees 
o Shares held by a trustee may be voted by him, either in person or by proxy, only 
after the shares have been transferred into his name as trustee or into the name of his nominee. 
o Once the transfer is complete, the trustee is the record owner of the shares. 

 

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What are treasury shares?

 

Can these shares be voted?

 

are they deemed outstanding shares?

 

Are they assets of the corp?

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2) Treasury shares 
• Treasury shares are shares of a corporation that were previously in the hands of investors but have now been repurchased or redeemed by that corporation and are being held in its “treasury.” 
• Additionally, if a parent corporation’s majority owned or wholly owned subsidiary 
buys some of the parent’s shares, those shares are also deemed to be treasury 
shares. 
• Treasury shares 
o Cannot be voted by the corporation; 
o Are not deemed to be “outstanding shares” for purposes of establishing a quorum for a shareholder meeting; and 
o Are not considered “assets” of the corporation. 

 

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Example 6: (Summer, 2010 Bar Exam): On X Corp’s record date for an upcoming shareholder meeting, Amy owned 10 shares of common stock, Brian owned 25 shares and Carter owned 35 shares. X Corp also had in its treasury 50 shares of stock that it had previously issued to, but later repurchased from, Amy. How many shares did X Corp have for purposes of the shareholder meeting?

Back 43

Because the 50 shares held by X Corp are “treasury shares,” those shares cannot be voted nor are they counted for quorum purposes. For purposes of the upcoming shareholder meeting, X Corp had 70 shares of issued and outstanding 
common stock (10 + 25 + 35 = 70). 

 

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Do bondholders or other debt security holders have voting rights?

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3) Bondholders 
Bondholders and other debt security holders are “contract claimants” of the corporation and thus have no voting rights unless their contract (or the corporation's certificate of incorporation) grants them voting rights.

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voting rights per share:

 

What if there's more than one class of shares?

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b. Number of Votes 
 Each share of stock typically entitles its holder to one vote. The number of votes per share can be changed, but only by a provision in the certificate of incorporation. 
 If a given corporation has more than one class or series of stock, the certificate of 
incorporation will delineate the respective voting powers of the several classes or series 
in all elections and other proceedings. 

 

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What must shareholders vote on?

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c. Shareholder Voting 
Shareholders are entitled to vote on the following: 
• Election of the board of directors; 
• amendments to the certificate of incorporation; 
• A sale of all or substantially all of the assets of the corporation; 
• mergers and consolidations; and 
• dissolution of the corporation. 
Note 4: Shareholders may be asked to vote on other matters as well, but their vote in that regard isn’t legally required. 

 

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What is a "quorum" of voters?

 

What is a quorum in NY?

 

Can a corp opt for a different % for its quorum?

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d. Quorum Requirements 
 In order to take legally binding action at a shareholder meeting, the holders of a critical 
mass of shares must be represented at the meeting, either in person or by proxy. This is 
the concept of “quorum.” Unless a quorum is achieved, shareholder action at a meeting 
is legally void . 
 In New York, the default rule is that a majority of all the outstanding shares 
entitled to vote constitutes a quorum. When a particular class or series of shareholders 
are entitled to a separate class vote, then a majority of the shares of such class or series 
constitutes a quorum. 
 The certificate of incorporation or by-laws may specify a lesser quorum than a majority, 
but no less than 1/3 of all the outstanding shares. A quorum greater than a majority may only be provided for in the certificate of incorporation. 
 Once a quorum is achieved at a shareholder meeting, it is not broken if shareholders 
leave.

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When is a class of shareholders entitled to vote?

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e. Separate Class Voting 
 If a proposed amendment to the certificate of incorporation would adversely affect the rights of any class or series of shares, then 
holders of shares of that class or series, voting as a separate class, are entitled to vote 
on the proposed amendment. This is in addition to holders of those shares voting 
collectively with all other shareholders on the proposed amendment.  Providing holders of those shares with a separate class vote gives them veto power over the proposed amendment. 
 The certificate of incorporation may contain provisions granting the holders of a 
particular class or series of shares with a separate class vote on other matters

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Example 7: XYZ Corp. has shares of common stock and preferred stock outstanding. The dividend rate on the preferred stock is 10%, as specified in the certificate of incorporation. Suppose that XYZ Corp. is experiencing financial difficulties. In order to conserve money, it would like to amend the certificate of incorporation to reduce the dividend rate on the preferred stock from 10% down 
to 4%. Obviously, such a change would have an adverse impact on the preferred shareholders. Common shareholders, however, would favor such a change, as it would make the corporation more economically viable, and thus works to their advantage. 

 

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In order to approve the proposed amendment, two votes are necessary. The 
first vote entails the common shareholders and preferred shareholders voting together as a single class. Normally, there are many more common shares outstanding than preferred shares, so the common shareholders will get their way in this vote. However, because the proposed amendment adversely affects 
the preferred shareholders, a second vote is needed. The preferred shareholders, voting alone as a separate class, must also approve the proposed amendment. If they do not, the proposed amendment fails. Thus, they have 
veto power over the proposed amendment, despite the fact that the common  shareholders favor it

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How are directors voted in?

 

How many votes does the shareholder get?

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f. Special Voting for Directors 
Directors are elected by a plurality of the votes cast at a shareholder meeting. This means that those director nominees receiving the most votes win. 
Example 8: Six director nominees are running for four open board seats. Who wins? The four nominees who receive the most votes win. 
1) Straight or traditional voting 
Normally, when a shareholder votes for a particular director nominee, the shareholder 
casts that number of votes for the nominee as equals the number of shares she owns. 

 

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Example of Special Voting for Directors:

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Example 9: Six director nominees are running for four open board seats. Susan, a shareholder owning 500 shares, is entitled to cast exactly 500 votes (and only 500 votes) per nominee for up to four nominees of her choosing. When Susan votes for a particular nominee, she must cast 500 votes for that nominee—no more, and no less. 

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Cumulative voting:

relevant for electing who?

who does it help?

how does it work?

 

Back 52

2) Cumulative voting 
• Cumulative voting is only relevant (if at all) in the context of an election of directors. 
• Cumulative voting is designed to help minority shareholders elect one 
or more director nominees of their choosing to the board. Cumulative voting for 
directors is only allowed when the corporation’s certificate of incorporation so provides. Otherwise, shareholders must vote for directors in the straight or traditional way. 
• When a certificate provides for cumulative voting for directors, each shareholder is 
entitled to cast that number of votes as equals the number of shares she she owns multiplied by the number of open board seats. 
She may then cast all of her votes for a single nominee, or spread them out (evenly 
or unevenly) over multiple nominees. 

 

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Example of cumulative voting for directors:

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Example 10: A owns 30 shares of X, Inc. stock. B owns the remaining 70 shares. X, Inc. has a board of directors with three open board seats. Without cumulative voting, A is unable to elect a nominee of her choosing because B 
owns a majority of the shares. With cumulative voting, A can elect at least one director by casting all of her 90 votes (i.e., 30 shares × 3 open board seats) for one nominee.

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Exam note:  how does the promoter get off the hook?

Back 54

-EXAM NOTE: The promoter will still remain personally liable on the contract unless there is a novation releasing him of liability by the corporation. 

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In New York, the limited liability ordinarily protecting owners of a corporate entity will be disregarded if it is necessary “to prevent fraud or to achieve equity,” or to prevent illegality.  

Times when courts will "pierce the corporate veil" and make people liable personally.

Back 55

i)    Excessive domination by shareholders (including a parent corporation);

EXAM NOTE: This often occurs in fact patterns in which the parent corporation exercises such direction and control over a subsidiary that the subsidiary can be deemed to have no identity of its own.

 

Front 56

Exam note:  what is the "test" the court uses to pierce the corp veil?

Back 56

EXAM NOTE:  There is no single test the court uses in determining whether or not to “pierce the corporate veil.”  Rather, it considers a number of contributing factors that would be in the interest of justice.

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How frequently are directors voted on?

 

What are classified boards and how are they voted on?

 

What is the purpose of a classifed board?

Back 57

a. Special Voting for Directors (cont.) 
1) Classified board 
• Typically, all directors of the corporation are up for reelection on an annual basis. However, if its certificate of incorporation so provides, a 
corporation’s board can be broken into two, three or four classes. Such a board is 
called a “classified board”. In this situation, each year directors within only one class are up for reelection, while the remaining directors are not and are referred to 
as “continuing directors”. 
• The number of directors in each class must be as nearly equal in number as possible. 
• The main purpose for a classified board is to prevent disgruntled shareholders from 
replacing all or a majority of the incumbent directors in a single  annual election. In the context of a classified board, it would take shareholders two or more years to oust the majority of the incumbent directors.

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Example of a classified board election cycle:

Back 58

Example 11: A corporation with a nine-member board of directors divides the 
board into three equal classes. This year, the three Class 1 directors are up for reelection. Next year, the three Class 2 directors are up for reelection. The following year, the three Class 3 directors are up for reelection. Directors who are not up for reelection continue in office until their class is up for reelection. 

 

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Voting by proxy:

Back 59

b. Proxy Voting by Shareholders 
 Because not every shareholder can personally attend a shareholder meeting (especially when the corporation is publicly traded and thus shareholders are dispersed across the country), shareholders are allowed to cast the corporate equivalent of absentee ballots.  In the corporate context, absentee voting is referred to as proxy voting. 
 When completing a proxy, a shareholder will appoint another person (typically a corporate officer) to vote her shares as she has directed in her proxy.

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How long is a proxy valid?

 

How is a proxy revoked?

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1) Expiration of proxy 
Proxies normally specify an expiration date. When no date is specified, a proxy is valid 
for 11 months, thus ensuring the proxy can only be used at one annual meeting and not two. 
2) Revocation of proxy 
• Except in the case of the irrevocable proxy, every proxy is revocable at the pleasure of the shareholder executing it. She may do so by: 

o Simply requesting in writing that her proxy be revoked at any time prior to the meeting; 
o Turning in another with a date later than the previous proxy; or 
o Attending the shareholder meeting in person and voting.

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When is a proxy NOT revoked?

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• A proxy is not revoked by the incompetence or death of the shareholder unless, before the proxy is utilized, written notice of an 
adjudication of such incompetence or death is received by the corporate officer responsible for maintaining the list of shareholders. 

 

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Example of proxy revocation:

Back 62

Example 12: (Summer, 2010 Bar Exam): Brian, believing he wouldn’t be able to attend X Corp’s annual shareholder meeting,completed a revocable proxy that authorized Dell to vote his shares as Dell (not Brian) saw fit. Dell then sent in a proxy which votes Brian’s shares against the shareholders’ proposal that was to be considered at the meeting. Before the meeting, Brian’s schedule changed in 
a way that allowed him to attend the meeting in person after all. He did so and voted his shares for the shareholders’ proposal. By attending the meeting in person and voting his shares, Brian has revoked the revocable proxy he gave to Dell. Brian’s votes count, while Dell’s votes do not. (Note: a different outcome 
would have occurred had Brian given Dell a proxy that met all the requirements 
of an irrevocable proxy.)

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Irrevocable proxies:

 

Consequences of an irrevocable proxy:

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3) Irrevocable proxy 
• Under the right conditions, a proxy may become irrevocable. Two important 
consequences flow from a proxy being irrevocable: 
o The holder of an irrevocable proxy—and not the shareholder —is entitled to vote the shares covered by the proxy as the proxy holder sees fit. 
In other words, the shareholder cedes her voting authority over the shares for the duration of the irrevocable proxy; and 
o The shareholder cannot revoke the irrevocable proxy for the duration of the proxy. Hence, the term “irrevocable proxy.”

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what are the two conditions that must both exist to make a proxy irrevocable?

 

The NY list of entities that can hold an irrevocable proxy:

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• Two conditions are necessary to make a proxy irrevocable: 
o The proxy must state on its face that it is irrevocable; and 
o The shareholder must give the proxy to someone who has an interest in the 
shares covered by the proxy (the concept of “coupled with an interest”). New York provides a laundry list of such individuals. They include: 

(i) A pledgee —i.e., a lender to whom the shares are pledged by the shareholder as collateral; 
(ii) A person who has agreed to purchase the shares; 
(iii) Any corporate creditor who extends or continues to extend credit to the corporation in consideration of the proxy (in such case, the proxy must state that it was given in consideration of the credit, the amount of the credit, and the name of the person extending 
or continuing the credit); 
(iv) A corporate officer whose employment agreement requires that he receive an irrevocable proxy (in such case, the proxy must state that it was given in consideration of such employment agreement, the name of the officer, and the period of employment contracted for); and 
(v) A person designated under a valid shareholders’ voting agreement. 

 

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When does an irrevocable proxy become revocable?

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• An irrevocable proxy becomes revocable after the proxy holder’s interest in the 
shares falls away or is terminated. 
Example 13: (2010 Summer Bar Exam): In the preceding example, the proxy Brian gave to Dell was not an irrevocable proxy for two reasons. First, it didn’t state on its face that it was irrevocable. Second, there was no indication that Dell had any interest in Brian’s shares. 

 

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Shareholders voting together:

 

What is a voting pool?

 

What is the remedy for the breach of a voting pool agreement?

 

How long does it last?

Back 66

c. Voting Together with other Shareholders 
1) Voting pool—retention of legal ownership 
• Shareholders may enter into a binding voting agreement, also known as a “voting 
pool,” in which they contractually agree on how they will vote their shares. Under such an agreement, shareholders retain ownership of their stock. 
• Specific enforcement is the remedy for breach of a voting pool agreement. 
• A voting pool agreement will last as long as the agreement specifies and does not 
need to be filed with the corporation. 

 

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What is a Voting trust?

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2) Voting trust—transfer of legal ownership 
• In contrast to the voting pool agreement is a voting trust. A voting trust is a 
separate legal entity to which the shareholders’ stock is transferred. 
• While the shareholders retain beneficial ownership of their shares (and thus they 
continue to receive interest and dividends 
from the corporation), legal ownership is transferre• A voting trust may be valid for up to 10 years (subject to extension for up to 
another 10 years) and requires the trust instrument to be filed with the corporation. 
• Despite transferring their shares to the voting trust, shareholders are still allowed to 
bring derivitive actions in the name of the corporation and inspect corporate books and records to the limited extent allowed under NY lawd to the trustee who then votes 
the shares pursuant to the terms of the trust agreement. 

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When and how may a shareholder inspect the corporate records?

 

May records be copied?

 

How much and what kind of notice must the shareholder give?

 

What is the inspection generally limited to?

Back 68

2. INSPECTION OF CORPORATE RECORDS 
o A shareholder has a right to inspect and copy specified corporate records during normal business hours. 
o To do so, the shareholder must give the corporation 5 days’ prior written 
notice. That notice must state a “proper purpose” for such inspection. 
o Generally, both record and beneficial owners of shares enjoy inspection rights. 
a. Records Subject to Inspection 
 By statute, New York limits a shareholder’s inspection right to: 
• minutes of shareholder meetings; and 
• A list of shareholders of record. 
 Additionally, shareholders have a common law right to inspect other corporate books 
and records at a proper place, at a reasonable time, and for a proper purpose.

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What is a proper purpose for a shareholder to inspect corp records?

 

What are improper purposes?

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b. “Proper Purpose” 
 A shareholder’s inspection right is conditioned on having a proper purpose. A proper purpose is one that relates to the shareholder’s interest in the corporation. 
 Improper purposes may include harassment of corporate officials, acquiring corporate 
secrets, or conducting illicit “discovery” in anticipation of a lawsuit against the 
corporation. 

 

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What info must the corp disclose without notice and without a shareholder purpose?

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c. Disclosure of Financial Information 
Upon a shareholder’s written request, the corporation must provide the shareholder with a copy of its annual balance sheet and a propfit and loss statement for the preceding fiscal year. A proper purpose need not be given in this context. 

 

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What is a shareholder's right to bring suit against the corporation?

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3. SUITS BY SHAREHOLDERS 
o A shareholder may bring a derivative action on behalf of the corporation for a harm suffered by the corporation. A derivative action is “derivative” in nature because the shareholder’s right to sue derives from the corporation’s right to bring the suit in the first instance. 
o Because the suit belongs to the corporation, the corporation must be made a party to the lawsuit. However, because the corporation is unable or unwilling to be the plaintiff, the shareholder bringing the suit must name the corporation as a nominal defendant. 

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Who are the defendants in a derivitive suit agaisnt the corp?

 

Who gets the recovery if the shareholder wins the suit?  What about attorney's fees?

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o The real defendants are typically the corporation’s own directors and 
officers who are accused of breaching their fiduciary duties. Because the corporation generally won’t sue its own directors and officers, the shareholders have to step in—through a derivative lawsuit—to protect the corporation. 
o Because the lawsuit belongs to the corporation, any recovery goes to the 
corporation and not the shareholder bringing the lawsuit. However, the court may award the plaintiff reasonable expenses, including reasonable attorney’s fees

Front 73

Who may bring a derivitive suit against the corp?

 

Who may not?

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a. Who May Bring Suit 
 Any record or beneficial shareholder, or a holder of a voting trust certificate, can commence a derivative lawsuit. 
 Any such holder must have standing. This means the plaintiff must be a holder at the time the action is brought and at the time of the transaction of which he complains. 
Note 5: A creditor of a corporation cannot bring a derivative action. 

 

Front 74

What must the shareholder do before he or she sues the corp in a derivitive action?

 

What is the futility exception to the demand requirement?

 

What is the best way around the demand requirement?

 

How is the action settled?

Back 74

b. Demand upon Board 
Generally, the plaintiff must make a written demand upon the board of directors for it to commence an action to resolve the problem before the plaintiff files his complaint. This is known as the “demand requirement”. In this regard, the plaintiff’s complaint must set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort. 
1) Futility exception 
• Demand is not required if it would be futile. Factors for determining futility include 
whether the directors are disinterested and independent, and whether the transaction complained of was the product of a valid exercise of the directors’business judgment. 
• The best way around the demand requirement is to allege facts with particularity indicating that the directors are self-interested in the transaction or are otherwise causing the harm to the corporation. 
2) Discontinuance or settlement 
A derivative action may not be discontinued or settled without the approval of the 
court.

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Who has and doesn't have a fiduciary duty and to whom and under what circumstances?

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4. SHAREHOLDER FIDUCIARY DUTIES 
o Shareholders who do not control the corporation have no fiduciary duties to either the corporation or its shareholders. 
o Controlling shareholders, however, do owe a fiduciary duty of good faith to the minority 
shareholders when the controlling shareholder is:

 Selling his controlling interest to an outsider; 
 Seeking to eliminate other shareholders from the corporation; 
 Receiving a distribution denied to the other shareholders; or 
 Seeking to dissovle the corporation. 

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How many directors must there be?

Back 76

A. BOARD OF DIRECTORS 
1. COMPOSITION REQUIREMENTS 
a. Number of Directors 
A board of directors may consist of one or more directors. The number of directors typically is set forth in a corporation’s bylaws. The number may be changed: 
• In accordance with the bylaws; 
• Through shareholder action; or 
• By the board itself if a shareholder-adopted by-law so provides. 

 

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How old must a director be?

 

Are there other qualifications to be a director?

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b. Qualifications of Directors 
Each director must be at least 18 years of age. The certificate of incorporation or by-laws may prescribe other qualifications for directors. 
Example 14: The by-laws may state that only current shareholders may serve as board members. 

 

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Who appoints the initial directors?

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2. SELECTION OF DIRECTORS 
o The initial directors are appointed by the incorporator at the organizational meeting. 
o Thereafter, directors are elected by the shareholders at the annual 
shareholder meeting. 

 

Front 79

How long does a director serve?  

 

What is an exception?

Back 79

3. TERM OF DIRECTORS 
a. Annual Terms 
 At each annual meeting, shareholders elect all the directors who will hold office until 
the next annual meeting. 
• An exception is the classified board, where shareholders elect directors to hold office until their class comes up for reelection. 
 The certificate of incorporation may provide that the holders of the shares of a specific 
class or series, voting as a separate class, are entitled to elect one or more directors to 
the board. 

 

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What happens if a director's term has expired and the corporation fails to hold an annual meeting?

Back 80

b. Holdover Director 
 Each director holds office until the expiration of the term for which he is elected, and until his successor has been elected and qualified. 
 Thus, if the corporation fails to hold an annual meeting, the existing directors continue in office until a “special meeting for the election of directors” is held. 

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How does a director resign?

Back 81

c. Resignation of a Director 
A director may resign at any time by delivering a written notice to the board, its chair, or the corporation itself. 

 

Front 82

How are directors removed?

 

By whom?

 

How is a director elected through a separate class vote removed?

 

How is a director elected through cumulative voting removed?

Back 82

d. Removal of a Director 
1) Removal for cause 
• Shareholders may remove a director for cause. “Cause” includes a director engaging in self-dealing, usurping a corporate opportunity, committing waste, or breaching another fiduciary duty. 
• Directors themselves may also remove a fellow director for cause if the certificate of 
incorporation or a shareholder-adopted by-law so provides. 
2) Removal without cause 
Shareholders may also remove a director without cause if there is a provision in the 
certificate or in a shareholder-adopted by-law that allows for it. 
3) Director elected through separate class vote 

A director who was elected through a separate class vote can only be removed by that 
class of shareholders. 
4) Director elected through cumulative voting 
A director elected by cumulative voting cannot be removed when votes sufficient to elect the director are cast against the director’s removal. 
 

 

Front 83

Example of who has the authority to remove a director when the certificate and by laws are silent.

Back 83

Example 15: (February, 2007 Bar Exam): Steve, a director of XYZ Inc., usurped a corporate opportunity belonging to the corporation. The board of XYZ Inc., upon learning what Steve had done, voted to remove him as a director. The certificate and by-laws of XYZ Inc. were silent on the issue of removing directors. 
Accordingly, only the shareholders of XYZ Inc.—and not the board—had the authority to remove Steve. 

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replacement of a director with a new director

Back 84

e. Replacement or New Director 
 When there is a vacancy on the board (e.g., due to the death or resignation of an 
existing director) or the board is expanded by one or more additional seats, either the 
shareholders or the directors may fill the vacancy. 
 In the case of directors, this is even true when the remaining directors do not constitute a quorum. A replacement director will serve out the remaining term of the former director. 

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Types of meetings (two)

 

1.  regular meetings - how frequently?

 

2.  special meetings - notice requirements?

Back 85

4. MEETING REQUIREMENTS 
a. Types of Meetings 
 The board of directors may hold regular or special meetings. 
 Regular meetings occur at fixed intervals, such as quarterly. 
 Special meetings (if any) occur between regular meetings. 
b. Notice of Meetings 
 A director is only entitled to notice of a special meeting. A director 
may waive notice of a meeting at any time by signing a written waiver to that effect. 
 In addition, a director’s attendance at that meeting itself waives notice of that meeting 
unless the director objects to the lack of notice.

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is a director required to be physically present at a meeting?

 

When can directors act without a meeting?

Back 86

c. Presence at Meetings 
 A director is not required to be physically present at a meeting. 
 A meeting may be conducted telephonically via a conference call or through any other 
technology that allows the directors to hear one another during the meeting. 
d. Action without Meeting 
The board of directors may also act without holding a meeting by executing a unanimous written consent to the action.

Front 87

What are the quorum rules for director actions?

 

IN order to count for quorum purposes, directors must....

 

May directors vote by proxy?

Back 87

5. VOTING REQUIREMENTS 
a. Quorum Rules 
In order for the board to take legal action, a quorum of directors must be present at the 
meeting. 
1) Number of directors 
A majority of the entire board of directors (without regard to vacancies) constitutes a quorum. However, the certificate of incorporation or a shareholder adopted by-law may set a higher or lower number. 
2) Presence of directors 
Directors must be present—either in person or telephonically—at the time a vote is 
taken in order to be counted for quorum purposes. 
Note 6: A director may not vote by proxy

Front 88

Required number of votes for director actions?

 

Can the bylaws allow for a greater than majority vote?  A less-than-majority vote?

 

Can directors make an agreement as to how they will vote?

Back 88

b. Required Vote 
 Typically, the assent of a majority of the directors present at a meeting at which a quorum exists is necessary for board approval. However, the certificate of incorporation or by-laws may specify a higher level of approval. 

 A level of approval below a majority vote is not allowed. 
c. Voting Agreements 
Generally, an agreement between directors as to voting is unenforceable, as each director is 
expected to exercise his or her independent judgment. 

 

Front 89

What document creates committees?

 

How many director votes are needed to designate a committee?

 

How many directors in a committee?

 

What are the three typical committees of most corporations?

 

Do closely-held corporations use committees?

Back 89

6. COMMITTEES 
o If the certificate of incorporation or the by-laws so provide, the board of directors may 
designate from among its members one or more committees. 
o A resolution adopted by a majority of the entire board (and not a majority of a quorum) is needed to designate a committee. 
o A committee may consist of two or more directors. 
a. Types of Committees 
 Typically, the board of a publicly-traded corporation has an audit committee (responsible for overseeing financial reporting and the preparation of financial statements), a compensation committee (responsible for 
recommending the compensation received by senior executive officers and board members), and a nominating committee (responsible for 
recommending nominees for open board seats). 
 Closely-held corporations typically do not utilize committees, although they may. 

 

Front 90

What powers do committees have?

 

What powers may committees not engage in?

Back 90

b. Committee’s Powers 
 A committee may generally exercise whatever powers are granted to it by the full 
board, the certificate of incorporation, or the by-laws. 
 Nevertheless, a committee may not engage in the following five actions: 
• the fixing of the compensation for board members or any committee member 
(although recommendations to the full board concerning compensation are fine); 
• Submitting to shareholders any action that requires shareholder approval; 
• Filling vacancies on the board or its committees; 
• Adopting, amending, or repealing bylaws; or 
• Amending or repealing any resolution of the board that is not expressly amendable or repealable. 

 

Front 91

May corps lend money to a director?

 

What are the 2 circumstances?

Back 91

7. LOANS TO DIRECTORS 
A corporation may not lend money to or guarantee the obligation of a director unless: 
 Holders of a majority of shares entitled to vote at a meeting at which a quorum is present vote to approve such loan or guarantee. Importantly, shares held by the director in question may not be voted nor are they considered for quorum purposes; or 

 The board approves the loan or guarantee after determining that it benefits the corporation. Because the loan or guarantee constitutes a self-interested transaction, board approval in this regard must comply with New York’s interested director statute.

Front 92

Is a director a fiduciary?

 

What is the standard?

Back 92

8. FIDUCIARY DUTIES 
The basis for a director’s fiduciary duties is found in the BCL. It states that a director must 
perform his duties as a director, including his duties as a committee member, in 
good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances.

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What is the director's duty of care?

Back 93

a. Duty of Care 
 A director has a duty of care. When making a business decision, he is obliged to act with the knowledge and skill of an ordinarily prudent person handling his own property. 
 Additionally, a director is held responsible for whatever special knowledge or skills he 
actually possesses. Thus, if you are a lawyer and serve on a corporate board, your actions will be measured against those of the ordinarily prudent lawyer.

Front 94

What information may directors rely on?

Back 94

1) Reliance 
In satisfying his duty of care a director is entitled to rely on information, reports, and 
opinions supplied by the following persons if the director reasonably believes those 
persons to be reliable and competent: 
o officers and other employees of the corporation; 
o Outside attorneys, accountants, or other skilled or expert individuals retained by 
the corporation as to matters within such individuals’ professional or expert 
competence; and 
o A committee of the board of which the director is not a member.

Front 95

What is the business judgment rule?

 

What is the effect of this rule?

 

IN determining if a director is liable for a decision, is the focus on the decision made or the process of making the decision?

 

What is the underlying principle behind this rule?

Back 95

2) Business judgment rule 
• The business judgment rule is a legal presumption that a director, when making a 
business decision, has satisfied his fiduciary duties to the corporation. Therefore, unless a demonstrable conflict of interest or bad faith exists, New York courts will not second guess the business judgment of the directors. 
• As a result of this presumption, directors are generally protected from claims based 
upon an alleged violation of their duty of care so long as the directors made an informed, good faith decision. 
• The focus is on the decision-making process, and not on the actual decision that was made.

Note 7: The business judgment rule reflects the judicial belief that the boardroom, and not the courtroom with the benefit of 20/20 hindsight, is the place where business decisions should be made. 

Front 96

What is the duty of loyalty for a director?

 

Three areas of breach?

Back 96

A. DUTIES (CONT.) 
1. Duty of Loyalty 
The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interest of the corporation. Typically, a director breaches this duty by placing his own interests before those of the corporation. Duty of loyalty issues arise in the following three 
situations: self-dealing transactions; usurpation of a corporate 
opportunity; and actions that lead to directors being entrenched in office.

Front 97

Who (and what) does self-dealing include?

Back 97

a. Self-dealing 
1) Self-dealing arises when a transaction occurs between the corporation in question and: 
• The director herself; 
• Persons who are related to the director (including the director’s immediate family, parents, siblings, and grandchildren, the spouses of these individuals, as well as a trust or estate of which any of those individuals is a 
substantial beneficiary or the director is a fiduciary); or 
• Another corporation in which the director either has a substantial financial interest or sits on the board of that other corporation. 
Note 8: When one or more directors sit on the boards of two corporations, those corporations are said to have “interlocking directorates”. 

 

Front 98

What is the concern regarding self-dealing by a director?

 

How can the director avoid liability for damages from self-dealing?

Back 98

2) When a self-dealing transaction occurs, concerns about the fairness of the transaction to the corporation arise. If the transaction is unfair to the corporation, the director is essentially profiting at the expense of her corporation. 
3) Therefore, unless the transaction is cleansed through New York’s interested director statute (a safe harbor rule), or is otherwise fair to the corporation, a court may enjoin or void it and subject the director to liability for damages. 

4) Safe harbor rules 
a) Approval of transactions - An interested director transaction is cleansed (i.e., not 
voidable) if one of the three cleansing processes occurs: 
i) The conflict is disclosed to the board and the board then approves the transaction in a manner that satisfies the normal board approval requirement but without counting the votes of interested directors;

 

Front 99

 

First way to cleanse a transaction where a director of the corp wants to borrow money from the corp:

The conflict is disclosed to the board and the board then approves the transaction in a manner that satisfies the normal board approval requirement but without counting the votes of interested directors

Example:

Back 99

Example 16: Assume a board has nine members, and thus a quorum of directors would be five (a majority of nine). Assume that seven of the nineboard members attend the meeting, and thus the quorum requirement is 
satisfied (both interested and disinterested directors are counted for quorum 
purposes). Further assume that one of the seven attendees is interested in the 
transaction. The normal board approval requirement is a majority vote of the 
directors at a meeting at which a quorum exists. In this case, four affirmative 
votes (a majority of the seven attendees) would be required. However, to cleanse the transaction in this way, the vote of the interested board member cannot be counted. Thus, to achieve the required four affirmative votes, four of the six disinterested directors would have to vote in favor of the transaction. 
Thus, if more than two disinterested directors voted against the transaction, it could not be cleansed in this manner. 

Front 100

Second way to cleanse a transaction where a director of the corp wants to borrow money from the corp:

ii) The conflict is disclosed to the board and the disinterested directors approve the transaction in a unanimous vote.

Example:

 

Third way:  

iii) The conflict is disclosed to the shareholders and the shareholders vote to approve the transaction. 

no example needed

Back 100

 

Example 17: Same facts as the previous example, except assume the number 
of interested directors is five instead of one. In this case, there are not four disinterested directors to approve the transaction. Therefore, to cleanse the transaction through a disinterested director vote, the vote of the disinterested directors must be unanimous. In this example, the two disinterested directors 
must both vote in favor of the transaction. 
 

 

Front 101

When a loan to a director from the corporation is not "cleansed" in one of the three ways, under what circumstances will a court allow the loan and not void it?  What is the test?

Back 101

5) Fairness of transaction 
a) If the transaction in question hasn’t been cleansed through a disinterested director 
or shareholder vote, courts will still not void it if the transaction was fair and reasonable to the corporation when approved. 
b) In deciding this, a court will look to see if the corporation received something of comparable value in exchange for what it gave to the director. 

Front 102

When can a shareholder challenge an interested director transaction?  Who bears the burden

Back 102

6) Burden of Proof 
a) Shareholders cannot challenge an interested director transaction that has been 
properly cleansed through a disinterested director or shareholder vote. 
b) However, if proper cleansing has not occurred, the burden is on the interested director/s to show that the transaction was fair and 
reasonable to the corporation at the time it was approved. If they can’t, a court will 
void the transaction. 

 

Front 103

Example of the process an interested director transaction might go through:

Back 103

Example 18: (February, 2008 Bar Exam): Susan is a director of ABC Ltd., a corporation with a three-member board of directors. She is also the sole ownerof Susan’s Catering, Inc. (“SCI”). When ABC Ltd. was in need of catering services, Susan recommended that it use SCI. After disclosing that she was the sole owner of SCI, the directors of ABC Ltd. (with Susan participating) voted on a contract with SCI. Susan and one other director voted “for” the contract; the remaining director voted “against” the contract. No cleansing occurred in this situation because Susan’s vote cannot be counted (although her presence counts for quorum purposes). The normal board approval requirement calls for a majority vote at a board meeting at which a quorum exists, but without counting the votes of interested directors. Thus, in the context of a three-member board where all three directors are in attendance, two of the three members would have to vote “for” the contract, excluding Susan’s vote. This has not occurred. Alternatively, the disinterested directors could unanimously approve the contract when the normal board approval requirement isn’t met. 

Here, the two disinterested directors were not unanimous. Despite the failure to cleanse this transaction, a court will not void it if it was 
“fair and reasonable” to the corporation when it was approved. Susan has the burden of showing this. If she fails, a court will void the contract if a shareholder challenges it. One thing Susan might do is show that third-party 
catering companies (those operating on an “arm’s-length” basis) would have offered the same deal that SCI offered to ABC Ltd. 

Front 104

What is a usurpation of corporate opportunity?

 

What are the two possible tests for "corporate opportunities?

Back 104

b. Usurpation of a corporate opportunity 
A director may also violate her duty of loyalty by usurping (i.e., taking) a corporate 
opportunity without first offering the opportunity to the corporation and waiting for the corporation to reject it. What is a “corporate opportunity?” In making this determination, courts have applied the “tangible expectancy” test or the “line of business” test. 

 

Front 105

What is the "tangible expectancy" test for "corporate opportunities?" (breach of director's duty of loyalty)

Back 105

1) “Tangible expectancy” test 
The corporation must: 
o Have an existing interest in the opportunity (e.g., an option to buy); 
o Have an expectancy in the opportunity arising from an existing right (e.g., purchase of property currently leased); or 
o Be actively seeking a similar opportunity. 

 

Front 106

What is the "line of business" test for "corporate opportunities?" (breach of director's duty of loyalty)

Back 106

2) “Line of business” test 
o Under the broader “line of business” test, the opportunity in question must fall 
within the corporation’s current or prospective line of business to be deemed a corporate opportunity. 
o Ordinarily, if a director pursues an opportunity that results in him competing against the corporation, that opportunity is a “corporate opportunity”.

Front 107

Other factors in the usurpation of corporate opportunities breach of director's duty of loyalty.

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3) Other factors courts may look at 
o The relationship between the person offering the opportunity and the director and/or corporation; 
o How and when the director acquired knowledge of the opportunity; and 
o Whether the director is an inside director (i.e., employee) or an outside director (i.e., non-employee). 

 

Front 108

What is the remedy when a director usurps a corp opportunity?

Back 108

4) Remedy - A director who usurps a corporate opportunity is required to hold that opportunity and any profits received thereby in a constructive trust for the benefit of the corporation. 

 

Front 109

When can a director seek indemnification and for what?

 

What are the three types of indemnification?

 

When is indemnification mandatory?

Back 109

2. Indemnification and Insurance 
When a director is involved in a legal action as a consequence of her role as a director, she may be able to seek indemnification for expenses incurred as well as for any judgment or award rendered against her. There are three types of indemnification: (i) mandatory, (ii) permissive, and (iii) prohibited. 
a. Mandatory indemnification 
 A corporation is required to indemnify a director for any expense, including court costs and attorney’s fees, incurred in the successful defense of a proceeding against the director in her role as a director. 
 In addition, a corporation must indemnify a director when so ordered by the court. 

 

Front 110

What is permissive indemnification of a director?

Back 110

b. Permissive indemnification 
In the event of the director’s unsuccessful defense of a lawsuit (including a settlement), a corporation may only indemnify the director when: 
• The director acted in good faith with the reasonable belief that her conduct was in the best interest of (or at least not opposed to the best interest 
of) the corporation; and 
• In the case of a criminal proceeding, the director had no reasonable cause to believe that her conduct was unlawful. 
• Permissive indemnification payments require the approval of a disinterested majority of directors or an independent attorney chosen by disinterested directors

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What is prohibited indemnification of a director?

Back 111

c. Prohibited indemnification 
 Indemnification that is neither mandatory nor permissive is prohibited. 
 Additionally, the corporation is prohibited from indemnifying a director for liability to 
the corporation in a shareholder's derivitive lawsuit, regardless of whether good faith was present, unless the corporation secures 
court approval to indemnify. 

 A corporation is also prohibited from indemnifying a director against liability due to the receipt of an improper financial benefit.

 

Front 112

When can the corp advance litigation expenses to the director?

 

When must a director repay?

 

What is the role of insurance?

Back 112

d. Advance of expenses 
 A corporation may, upon a petition by the director, advance litigation expenses to the 
director. 
 The director must repay those expenses if the director is ultimately not entitled to 
indemnification. 
e. Liability insurance 
A corporation may acquire insurance to indemnify directors for actions arising from their service as directors, except where active and deliberate dishonesty or illegal gain occur, in which case insurance may pay only the cost of defense.

Front 113

When can a director inspect and copy corporate books and documents?

Back 113

B. INSPECTION RIGHTS OF DIRECTORS 
• A director is entitled to inspect and copy corporate books, records, and other documents for any purpose related to the performance of her duty as a director. 
• A director can seek a court order to enforce this right if the corporation refuses. 

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Officers - generally

 

What is an officer who is also a director called?

Back 114

A. OFFICERS 
1. TYPES 
o Typically, a corporation’s bylaws specify the types of officers the corporation may have. These may include a president, vice-president, secretary, and treasurer. An individual may hold more than one office, and, in the context of a closely held corporation, typically does. 
o A director can also serve as an officer (and vice versa). When she does, she is referred to as an “inside director”.

Front 115

Who appoints officers and how?

Back 115

2. SELECTION 
o Normally, the board of directors has the power to appoint and remove officers. 
o Unless otherwise provided in the certificate of incorporation or the by-laws, all officers are 
elected or appointed to hold office until the meeting of the board following the next annual meeting of shareholders. 

 

Front 116

where to officers get their authority?

Back 116

3. AUTHORITY 
o The duties and authority of a given officer will be specified in the by-laws. 
o To the extent the by-laws fail to do so, the board may—by resolution —
decide such duties and authority. 

 

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What is the duty of care of an officer?

Back 117

4. DUTIES – CARE AND LOYALTY 
o The fiduciary duties of care and loyalty that are imposed on directors are also imposed on 
the officers of a corporation. 
o Like a director, an officer is also entitled to rely on reports, opinions, and statements 
prepared by other officers or outside advisors, so long as the officer does so in good faith.

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What is the liability of an officer?

Back 118

5. LIABILITY 
o As an agent of the corporation, an officer does not incur liability to third parties merely for the performance of her duties. 
o Of course, an officer can be liable to a third party when the officer has acted in her 
personal rather than corporate capacity or has engaged in purposeful tortious behavior. 

 

Front 119

What is the right of indemnification of an officer?

Back 119

6. INDEMNIFICATION AND INSURANCE 
o An officer is entitled to indemnification to the same extent and subject to the same 
restrictions as a corporate director. 
o Similar insurance rules apply as well. 

Front 120

When and how can an officer be removed?  What if there's an employment contract?

Back 120

7. REMOVAL 
o The board may remove any officer it appointed at any time with or without cause. 
o The existence of an employment contract with the officer does not change this, but may 
give rise to a breach of contract claim.

Front 121

What is a merger and what is a consolidation?

 

What do you call the corp that is left after a merger?

Back 121

B. MERGERS AND ACQUISITIONS 
1. STATUTORY MERGERS 
a. Definition 
A merger is the combination of two corporations, whereby one corporation will merge “with and into” the other corporation (known as the “surviving corporation”). 
Note 9: A consolidation is simply a merger involving more than two corporations. Typically, two corporations will form an entirely new corporation and then consolidate with that new corporation

Front 122

What is the effect of a merger?

 

Three requirments for merger?

 

What does merger to to the surving corp's cert of incorporation?

Back 122

b. Effect of Merger 
By operation of law, the surviving corporation assumes both the assets and liabilities of the corporation merging out of existence. 
c. Plan of Merger 
The board of each corporation proposing to merge must adopt a plan of merger, which 
includes the terms and conditions of the proposed merger and other “necessary or 
desirable” provisions. 
d. Procedure for Merger 
 The boards of each corporation must approve the merger; 
 Shareholders of each corporation must approve the merger; and 
 A certificate of merger must be delivered to the New York Department of 
State. 
Note 10: Because the surviving corporation’s shareholders vote on the merger, 
the certificate of merger may amend the surviving corporation’s certificate of incorporation. Thus, a merger is an alternative way to amend a corporation’s certificate of incorporation. 

 

Front 123

Voting requirements for mergers?

Back 123

1) Shareholder approval 
a) Voting requirements 
o For corporations formed on or before February 22, 1998, the merger must be 
approved by holders of 2/3 of all the outstanding shares entitled to vote. 

o For corporations formed after that date, or where the certificate of incorporation expressly states, the plan must be approved by holders of a majority of all the outstanding shares entitled to vote. 

 

Front 124

When is a separate class form required in a merger?

Back 124

b) Voting by class 
When the corporation has more than one class of stock outstanding and when the 
post-merger certificate of incorporation of the surviving corporation contains a change that would have entitled a particular class to a 
separate class vote if that change had been proposed as an amendment to the 
certificate, the holders of that particular class of stock must also approve the merger 
voting as a separate class.

Front 125

What is a short form merger?

Back 125

2) Short form mergers 
• If a parent corporation owns 90 percent or more of the outstanding shares of 
a subsidiary corporation, the parent may merge with the subsidiary without the 
approval of the board of directors or shareholders of the subsidiary. 
• If the parent corporation will not be the surviving corporation, approval of the 
parent’s shareholders is needed.

Front 126

How are assets sold?

 

Who must approve when substantially all assets are sold?

 

Who first authorizes the sale before its submitted to a vote of the shareholders?

 

What are the voting requirements?  Pre98?  Post 98?

Back 126

2. ASSET SALES 
Shareholders must approve the sale or other transfer of all or substantially all of a corporation’s assets. 
a. Board Authorization 
The board must first authorize the proposed sale or transfer and direct its submission to a 
vote of shareholders. 
b. Approval of Shareholders 
 The required vote is the same as for mergers. Approval by the holders of 
2/3 of all the outstanding shares entitled to vote is required for corporations formed on or before February 28, 1998. 
 For corporations formed after that date, or where the certificate of incorporation 
expressly states, the sale must be approved by the holders of a majority of all the outstanding shares entitled to vote. 

 

Front 127

After a corp sells all or substantially all of its assets to another, who is liable for the corporation's preexisting debts?

Back 127

c. Seller’s Liabilities 
1) Seller’s continued responsibility 
A corporation that sells all or substantially all of its assets generally remains liable for its 
debts, including the ones associated with the transferred assets, except for those debts 
that the buyer corporation explicitly agrees to assume. 

Front 128

Does the buyer have any liability for the seller corp's debts?  When?

 

What scenarios should alert you to the likelihood that buyer corp will be liable for seller corp's debts.

Back 128

2) Buyer’s escape from liability 
The law holds the buyer corporation liable for the seller corporation’s liabilities in four 
situations: 
o When the buyer corporation explicitly assumes such liabilities; 
o When the asset sale constitutes a defacto merger of the seller and buyer corporations; 
o When the buyer corporation is a mere continuation of the seller corporation; or 
o When the asset sale was designed to to

defraud the seller corporation’s creditors.

Note 11: With respect to the de facto merger and mere continuation situations, 
look for the following factual scenarios: 
• Buyer corporation purchases assets from the seller corporation and then essentially continues the same business as the seller corporation but doesn’t assume any of seller corporation’s liabilities. 
• The owners of the buyer corporation are the same owners who owned seller corporation (i.e., there is an “identity of ownership”). 
In these two scenarios, the asset sale looks to be motivated by an intent to defraud the seller corporation’s creditors. 

Front 129

Example 19: (February, 2009 Bar Exam): Seller Inc. sold all of the assets of its scaffolding business to Scaffold Corp., a newly formed corporation, pursuant to an agreement that was silent as to the assumption of Seller Inc.’s liabilities. Scaffold Corp. continued to manufacture scaffolding, using the same 
manufacturing plant, the same employees and the same trade names for its products as Seller Inc. had used. A scaffold previously sold by Seller Inc. collapsed and injured several workers. Among the defendants sued by the 
workers was Scaffold Corp., even though Scaffold Corp. did not manufacture the actual scaffold that had collapsed. 

Can the worker's successfully sue Scaffold Corp?

Back 129

The workers may be successful in suing Scaffold Corp. based on successor liability. Although Scaffold Corp. did not explicitly assume any of Seller Inc.’s liabilities, it carried on Seller Inc.’s business in the exact same manner as Seller Inc. had conducted it. It may be viewed as a “mere continuation” of Seller Inc. 

 

Front 130

Can a corp buy the stock of another corp?  What result?

Back 130

3. STOCK ACQUISITION 
A corporation may acquire stock in another corporation and thereby secure control of that 
corporation without merging into it. As a result, that corporation becomes a subsidiary of the acquiring corporation. 

Front 131

When does a shareholder have appraisal rights and what the heck are appraisal rights, anyway?

Back 131

4. DISSENTING SHAREHOLDER’S RIGHT OF APPRAISAL 
o Under certain circumstances, a shareholder may not have to go along with the “will of the 
majority” in connection with a fundamental corporate transaction, such as a merger. 
Instead, a shareholder may be entitled to have his shares bought for cash at a price equal to 
their fair value as determined by a judge in an appraisal proceeding. 
o Appraisal rights are available in the following three situations: 
 In a merger or consolidation, so long as the shareholder dissents to the merger or consolidation; 
 In a sale of all or substantially all of the assets of the corporation, unless the sale is an 
all cash sale that is followed by the dissolution of the corporation; and 
 In the context of an amendment to the certificate of incorporation, if such amendment materially and adversely affects the rights of a shareholder and the shareholder doesn’t vote in favor of the amendment. 

Front 132

Voluntary vs. involuntary dissolution

 

What changed on Feb 22, 1998?

 

Is board approval required?

Back 132

A. TERMINATION OF CORPORATE STATUS 
A corporation’s status as a corporation may be terminated either voluntarily by 
agreement or involuntarily by court order or state action. 
1. VOLUNTARY DISSOLUTION 
a. Authorization 
 For corporations in existence on or before February 22, 1998, dissolution must be approved by the holders of 2/3 of all the outstanding shares entitled to vote. 
 For corporations formed after that date, or where the certificate of incorporation 
expressly states, the dissolution must be approved by the holders of a majority 
 of all outstanding shares entitled to vote. 
Editor's Note 1: For a corporation in existence on February 22, 1998, 
dissolution must be approved by the holders of two-thirds of all the 
outstanding shares entitled to vote. 
Note 12: Board approval is not required in this context. 

 

Front 133

Under what circumstances may a shareholder dissolve the corporation at will?

 

What is the filing requirement for dissolution?  

 

When is the corporation actually dissolved?

Back 133

b. Certificate of Incorporation 
The certificate of incorporation may contain a provision that allows any shareholder, or the holders of any specified number or proportion of shares, to dissolve the corporation at will 
or upon the occurrence of a specified event. 
c. Certificate of Dissolution 
 To dissolve the corporation, a certificate of dissolution must be signed and delivered to the Department of State. The consent of the State Department of Taxation and Finance must accompany the certificate. 
 The corporation is dissolved once the Department of State has filed the certificate. 

 

Front 134

Involuntary dissolution:

Who may bring the action?

Under what circumstances?  (3 situations)

Back 134

a. The State 
The state, acting through the attorney general, may dissolve a corporation involuntarily if: 
• Its formation was based on fraud; 
• It engages in illegal or fraudulent courses of action; 
• It abuses its corporate power or commits ultra vires acts; or • It fails to pay fees or taxes or to file required reports or notices, thus forfeiting its right to exist. 

 

Front 135

How may shareholders pursue involuntary dissolution?  Under what circumstances?

 

What is director deadlock?

 

What is shareholder deadlock?

 

When can minority shareholders petition the court to dissolve?

Back 135

b. Shareholders 
1) Shareholders may pursue the involuntary dissolution of a corporation under the following four circumstances: 
• Insufficient assets: shareholders may adopt a resolution stating that they find that the corporation’s assets are not sufficient to discharge its liabilities; 
• Beneficial action: shareholders may adopt a resolution stating that they deem a 
dissolution to be beneficial to the shareholders; 
• Director or Shareholder Deadlock: holders of at least 50% of all the outstanding shares entitled to vote in the election of directors may petition for dissolution based on either: 
o Director Deadlock: the inability of directors to take action to manage the 
corporation because they are divided against each other; or 
o Shareholder Deadlock: the inability of shareholders to elect directors because 
the shareholders are divided against each other. 
• Oppressive Conduct: solely in the context of a closely held corporation, minority shareholders owning at least 20% of a corporation’s stock may petition the court to dissolve the corporation based on oppressive conduct directed towards them.

Front 136

What is oppressive conduct?  According to the BCL and according to the courts?

 

What do courts take into consideration to determine oppressive conduct?

Back 136

2) What is “oppressive conduct”? 
• The BCL mentions directors or controlling shareholders engaging in illegal, 
fraudulent, or oppressive actions toward the minority shareholders. 
Such actions may also include the looting or wasting of corporate assets, or the 
diverting of corporate assets for non-corporate purposes. 
• Courts have held that oppressive conduct is “conduct that substantially defeats the 
‘reasonable expectations’ held by minority shareholders in committing their capital to the particular enterprise.” Reasonable expectations may include: 
o Continued employment at the corporation; 
o Receiving a share of corporate earnings; and/or 
o Having a “voice” in corporate management, by either being a corporate 
officer or director. 
Note 13: In assessing whether oppressive conduct has taken place, a court will 
determine what the majority shareholders knew or should have known regarding the expectations of the minority in joining the 
enterprise. 

Front 137

What may controlling shareholders do to avoid corporate dissolution?

 

What relief for minority shareholders?

Back 137

3) Buy-out right 
• Within 90 days of a petition based on oppressive conduct, the controlling 
shareholders may offer to purchase the minority shareholders’ shares at a 
reasonable price to avoid corporate dissolution. If the parties cannot agree on a reasonable price, the court may set one. 
• A buy-out avoids dissolving an otherwise economically viable corporation, and 
serves as the corporate equivalent of a “divorce.” 
Note 14: The minority shareholders may also sue for breach of fiduciary duty if 
the oppressive conduct of which they complain also constitutes a breach of 
fiduciary duty. 

 

Front 138

Example 20 about oppressive conduct: (July, 2007 Bar Exam): Susan, Tom, and Sam formed Eat Here Corp., a new corporation devoted to operating a restaurant. Each became a director, officer, and one-third owner of the corporation. While Tom and Susan paid cash for their shares, Sam entered into a binding obligation to act as chef and general manager of the restaurant for one year in exchange for his shares. Tom and Susan also agreed that Sam should receive an annual salary of $60,000 to run the restaurant for as long as Sam was a shareholder. The restaurant was very successful and profitable. Sam’s contract to run the restaurant was renewed several times; however, Tom and Susan refused to give Sam a raise. Moreover, they steadfastly refused to approve any dividend or distribution of money to the shareholders. After Sam vocalized his displeasure about monetary matters, Tom and Susan voted to oust Sam as an officer and director of the corporation and terminate his services as chef and general 
manager

Back 138

Sam owns more than 20% of the outstanding shares and thus is entitled to bring suit to dissolve the corporation based on oppression. However, were Sam’s “reasonable expectations” defeated by Tom and Susan? Sam’s expectations as 
to his salary were not frustrated, as a salary increase was never discussed. 
Moreover, a shareholder has no general right to a dividend or distribution. 
Nevertheless, Sam did have a reasonable expectation of continued employment 
at the corporation, the receipt of a share of corporate earnings and a voice in 
management (as an officer and director). Sam clearly expected a return on his 
investment through his salary and distributions. Once he was ousted, he had no other way to receive any return on his investment. Thus, Sam would likely 
succeed in an oppression proceeding to dissolve the corporation; however, Tom 
and Susan would have the option to purchase Sam’s shares at a “reasonable 
price” so as to avoid dissolution of an otherwise viable corporation. 

Front 139

Under what circumstances may directors petition for dissolution?

Back 139

c. Directors 
A majority of the board of directors may pursue the involuntary dissolution of a corporation under the following circumstances: 
• Insufficient assets: the majority adopts a resolution stating that it finds that the 
corporation’s assets are not sufficient to discharge its liabilities; or 
• Beneficial action: the majority adopts a resolution stating that it deems a 
dissolution to be beneficial to the shareholders. 

 

Front 140

Dissolution:

 

Can a corporation which has just been dissolved continue to act as a corporation?  If so, for what purpose?

Can it sue and be sued?

What does it do with its assets?

Where do proceeds go?  

Who is the priority creditor?

Where does the remainder go?

 

Back 140

3. EFFECT OF DISSOLUTION 
• Upon dissolution, the corporation must wind up its affairs and distribute its assets. It may continue to act as a corporation solely for the purpose of doing so, and it may sue and be sued in its corporate name during this time. 
• As part of the winding up process, the corporation will turn its assets into cash by selling them. 
Proceeds will then go first to pay legitimate creditors of the corporation, with employees claims to wages having priority over other creditors’ claims. 
• To the extent proceeds remain after paying creditor claims, the remaining assets will be split amongst the shareholders in accordance with their respective rights. 

Front 141

What is common stock?

Back 141

CHAPTER 9: STOCK AND OTHER SECURITIES GENERALLY 
A. STOCK AND OTHER CORPORATE SECURITIES 
1. TYPES OF SECURITIES 
Traditionally, a corporation will issue stock and debt securities to raise the capital needed to run its business. 
a. Stock 
Two types of stock may be issued by a corporation: 
1) Common stock 
• Under the BCL, every corporation is required to have stock that entitles its holders 
to vote for directors and represents the basic ownership interest in the corporation. 
• Common stock possesses these two characteristics.

Front 142

What does it mean that common shareholders' ownership is "residual."

Back 142

Note 15: While holders of common stock are considered the “owners” of the 
corporation, their ownership rights are residual in nature. In the context of a corporate dissolution, common shareholders receive any assets 
remaining only after creditors and preferred shareholders (if any) are paid in full. 

 

Front 143

What is one preference that  makes preferred stock "preferred?

 

Back 143

2) Preferred Stock 
A corporation may also issue shares of preferred stock to raise capital, so long as its certificate of incorporation authorizes shares of preferred stock. 
(Many certificates do not authorize preferred stock, and thus many corporations do not have the ability to issue it.) Shares of preferred stock have two preferences over shares of common stock. That’s why it’s called “preferred stock.” 
• Dividend preference 
o Dividends on preferred stock are contractual in nature. For example, each share of preferred stock may entitle its holder to an annual dividend of five dollars. 
o Preferred shareholders must receive their dividend in full before any dividends 
can be paid to the common shareholders. 

 

Front 144

What is another preference of preferred stockholders?

Back 144

• Liquidation preference 
o Preferred stock’s liquidation preference is contractual in nature as well. For 
example, upon liquidation of the corporation, each share of preferred stock may entitle its holder to a payment of $20. 
o Preferred shareholders must receive their entire liquidation preference (in this 
example, $20 per share) before any remaining assets are paid 
over to the common shareholders. 

Note 16: Preferred shareholders are entitled to their liquidation preference only after all the creditors of the corporation are paid back in full. 

 

Front 145

What are the three types of debt securities of a corporation?

 

Which ones are long term and which ones are short term?

Back 145

b. Debt Securities 
 Three types of debt securities may be issued by corporations: bonds, debentures, and notes. All are “IOUs” in which the corporation promises to pay back the amount borrowed (i.e., the “principal”) upon their maturity date and interest along the way. 
 Bonds and debentures are long-term IOUs (typically 10–30 years), while notes are shorter-term IOUs (typically 3–10 years). 

 

Front 146

What document authorizes rights and rules regarding issuing stock?

Back 146

2. ISSUANCE OF STOCK 
A corporation’s certificate of incorporation will set forth the type and number of shares of stock the corporation may issue to raise capital. 
a. Authorization 
 Shares of stock may all be of one class (i.e., common stock) or may be divided into two or more classes (e.g., common stock and preferred stock). 
 The certificate of incorporation will designate the classes of shares. Additionally, it will 
specify a given class’s par value (if any) and the class’s voting, dividend, and liquidation 
rights, as well as other rights, preferences, and limitations. 

 

Front 147

What consideration may investors give in exchange for shares of stock?

 

Is past consideration ok?

Back 147

b. Consideration 
1) Type of consideration - Investors may give one of the following six valid forms of 
consideration in exchange for shares of stock: 
• money; 
• property, whether tangible or intangible; 
• labor or services actually received by or 
performed for the corporation or for its benefit (including services performed 
before the corporation’s formation by a promoter and others); 
Note 17: In this context, past consideration is good consideration. 

• A binding obligation to pay the purchase price or the subscription price in cash or other property; 
• A binding obligation to perform future services having an agreed 
value; or 
• A combination of the foregoing. 

 

Front 148

Who decides how much the investor's consideration is worth?

Back 148

Note 18: In the absence of fraud, the board's judgment as to the value of any non-cash consideration received for shares is conclusive.

Front 149

Example 21 regarding consideration: (July, 2007 Bar Exam): Sam, Tom, and Susan formed Eat Here Corp., a new corporation devoted to operating a restaurant. Tom and Susan both invested $50,000 in exchange for their shares. Sam entered into a binding obligation to act as chef and general manager of the restaurant for one year, the agreed value of which was $50,000, in exchange for his shares. 

 

Back 149

All three shareholders have given valid consideration in exchange for his or her 
shares. Tom and Susan gave cash; Sam entered into a binding obligation to 
perform future services having an agreed-upon value. 

Front 150

Par value issues:

 

What is par value?

 

All the stock taken together =

 

What is stated capital?

 

What is watered stock?

Back 150

2) Stock with Par Value and No Par Value 
a) Par value stock 
o Shares of a given class of stock may or may not have an associated “par value” 
specified in the certificate of incorporation. Shares with par value may not be 
issued for an amount less than their stated par value. 
o Par value: the minimum dollar amount for which a share of stock may be legally 
sold. However, corporations typically attempt to sell their shares for an amount 
well in excess of par value. 
o The aggregate dollar amount of the par value of all the shares sold by the 
corporation constitutes the corporation’s stated capital. Stated capital is an 
account that appears on the corporation’s balance sheet. 
o Stock issued for less than par value is called “watered stock.” A holder of watered stock is liable to the corporation (or, if the corporation no longer exists, to the corporation’s creditors) for the difference between the par value of the stock and the amount he paid for the stock. 

 

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What happens when stock has no stated par value?

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b) Stock without a stated par value 
o Shares without an associated par value are considered “no par value” shares. It 
is up to the board of directors to decide each time the corporation sells “no par value” shares what portion of the consideration received for those 
shares will be considered part of the corporation’s stated capital account. 
o Thus, the dollar amount flowing into stated capital account can vary every time 
the corporation sells shares of no par value stock. 

 

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What is the liability for failure to pay consideration for the stock?

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3) Payment of consideration 
• A shareholder who fails to pay the consideration for his shares is liable to the 
corporation for that amount. 
• Upon dissolution, a creditor of the corporation may be able to recover the unpaid amount from a shareholder who failed to pay for his shares. 

 

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What is a stock subscription?

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c. Stock Subscriptions 
Prospective investors may subcribe to purchase stock from a corporation 
that has yet to be formed. However, in order to be enforceable, the subscription must be 
in writing and signed by the subscriber. 

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Revocability of stock subscriptions and nonpayment by subscribers:

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1) Revocability - Unless the subscription agreement provides otherwise, a subscription is irrevocable for three months, unless all the other subscribers consent. 
2) Nonpayment by subscriber 
• The corporation may proceed to collect any amount due from a subscriber who 
defaults in the payment of any installment due on a subscription. 
• Alternatively, the board may declare a forfeiture of the subscription, so long as 
written demand for payment was first made and 30 days have transpired without payment.

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What is "preemptive rights?"

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d. Shareholder’s Preemptive Rights 
 Under the common law, shareholders were entitled (but not obligated) to maintain their percentage ownership in a corporation whenever the corporation sold additional shares of common stock for cash. They could do so by purchasing their pro rata share of the new shares being sold. This entitlement is referred to as “preemptive rights”. 
 For corporations in existence before February 22, 1998, shareholders have 
preemptive rights relating to new offerings of common stock unless the certificate of 
incorporation denies preemptive rights. 
 For corporations formed on or after February 22, 1998, shareholders do not have preemptive rights unless the certificate of incorporation specifically grants them.

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EXample of preemptive rights:

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Example 22: A and B, the only shareholders of Corporation X, each own 50 shares of stock, and thus both have a 50% ownership interest. The board of directors of Corporation X authorizes the issuance of 20 shares of stock. With preemptive rights, A and B would each be entitled (but not obligated) to purchase 10 additional shares of stock (i.e., 50% of the new offering) and thus maintain his 50% ownership interest in the corporation. 

 

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Exceptions to preemptive rights:  when are shareholders not entitled to exercise their preemptive rights?

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 Exceptions 
Even when preemptive rights exist, shareholders are generally not entitled to exercise their rights when the new shares of stock are: 
• Given as compensation to corporate directors, officers, or employees; 
• Exchanged for property rather than cash; and 
• Taken from the treasury (i.e., treasury shares).

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Do all corporate stocks have a stock certificate?

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e. Share Certificates 
A corporation’s shares may be either certificated or uncertificated. Certificated shares are represented by a stock 
certificate. A stock certificate must be signed by: 

- the chairman or vice-chairman of the board or the president or vice president and 

- The secretary or an assistant secretary, or the treasurer or an assistant treasurer. 

 

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What is the most common form of distribution?

 

What are other forms?

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A. STOCK AND OTHER SECURITIES (CONT.) 
1. DISTRIBUTIONS 
o A distribution involves a corporation’s transfer of cash or other property to one or more of 
its shareholders. The most common form of distribution is a dividend, which is normally a cash payment made to all holders of a given class of stock. 
o Other forms of distribution include a corporation’s distribution of its debt securities to its shareholders and a corporation’s repurchase of its own stock (which puts cash into the hands of those shareholders who sell their shares back to the corporation).

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Who decides if distributions are made?

 

When can the board be forced to make a distribution?

 

What is the NY legal capital rule?

 

What are the two parts?

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a. Authorization—Board of Directors 
Distributions are payable at the discretion of the board of directors. Accordingly, a 
shareholder generally cannot compel the board to authorize a distribution unless the board has abused its discretion and refused to declare a distribution in bad faith. 
b. Limitations on Distributions 
 In addition to being payable at the discretion of the board, distributions are subject to 
New York’s legal capital rule—a rule designed to help protect creditors of the corporation. 
 The rule has two parts: an insolvency determination; and a surplus/net profits 
determination. Both parts must be satisfied for a corporation to make a 
legal distribution.

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NY Legal Capital Rule - 2 parts:

1.  Insolvency determination:  

2.  Surplus/Net Profits determination:

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1) Insolvency determination 
• Distributions may not be made if the corporation is either insolvent or would be 
rendered insolvent as a result of the payment of the distribution. 
• A corporation is “insolvent” when it is unable to pay its debts as they become due in the usual course of business. 

2) Surplus/Net Profits determination 
• If a corporation has a positive dollar amount of surplus, then the maximum aggregate distribution that a board can declare (assuming solvency) is equal to that 
surplus amount. 
• If a corporation has a zero or negative dollar amount of surplus, then the maximum 
aggregate distribution that a board can declare (assuming solvency) is equal to the 
corporation’s net profits for the current fiscal year and/or the previous fiscal year.

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What is the formula to determine surplus?

 

If surplus is zero or less, can a distribution be made?  Based on what?

 

What are net profits?  What's the formula?

 

What is the distribution "mantra?"

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• What is “surplus”? Surplus is an amount determined by looking at the balance sheet of the corporation: 
SURPLUS = TOTAL ASSETS – TOTAL LIABILITIES – STATED CAPITAL 
Note 19: If surplus is a zero or negative dollar amount, a distribution may still be made out the corporation’s net profits in the current fiscal year and/or the previous fiscal year (assuming solvency). 
• What are “net profits?” Net profit is an amount determined by looking at the profit 
and loss statement (i.e., the “income statement”) of the corporation: 
REVENUES – EXPENSES = NET PROFIT (OR LOSS) 
Note 20: Distribution “mantra”- Dividends and distributions are payable at the discretion of the board of directors and then only out of funds legally available for the payment thereof. 

 

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What is dividence equality?

 

When do you have to be a shareholder in order to recieve a dividend?

 

Who gets a dividend if the board doesn't set a dividend record date?

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c. Dividends 
1) Dividend Equality 
When the board declares a dividend on a given class or series of stock, all holders of shares of that class or series must receive the dividend based on the number of shares they hold. 
2) Dividend Record Date 
• Holders of shares on a dividend record date set by the board of directors are the ones entitled to a dividend. This is important given that shares of publicly traded companies are changing hands on a daily basis. 
• Holders of shares on a dividend record date are entitled to the dividend even if they 
no longer hold the shares when the dividend is actually paid. 
• When the board does not set a dividend record date, the dividend is payable to 
persons who are shareholders on the date that the board authorized the dividend

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This is an example of who gets paid a dividence when it's declared:

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Example 23: The board of XYZ Corp. selected November 15 as the dividend 
record date for an upcoming dividend to be paid on December 1. Trina owned 
shares on November 15 but sold them prior to December 1. Despite the fact 
that Trina no longer owns the shares, she is entitled to receive the dividend. 

 

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What is outstanding stock?

 

What is redemption?

 

What is treasury stock?

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d. Stock Purchase and Redemption 
 Stock authorized under the certificate of incorporation that has been issued to and is in the hands of investors is known as “outstanding stock”. Such stock may be reacquired by the corporation through purchase or redemption. 
 Redemption occurs when the corporation exercises a contractual right to buy back 
stock. Reacquired stock is called “treasury stock.” 

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Is treasury stock outstanding?

 

How are treasury stocks often used?

 

What are stock dividends?  What is important to remember about them?

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e. Treasury Stock 
 Treasury stock is considered authorized and issued but not outstanding. 
 Treasury stock can be resold in the future to raise capital until such time as it is retired 
and cancelled. The number of a corporation’s authorized shares is automatically reduced by the number of outstanding shares that are 
retired and cancelled. 
f. Stock Dividends—Not a Distribution 
Dividends consisting of a corporation’s own authorized but unissued shares (including 
treasury shares) are called stock dividends. Stock dividends are not subject to New York’s 
legal capital rule. 

 

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What restrictions on the sale of stock are valid?

 

What are First Option restrictions?  How is the price determined?

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2. SALE OF SECURITIES 
o Because stock is personal property, a shareholder is generally free to sell 
his stock to anyone at any time or price. In fact, New York law forbids unreasonable 
restraints on the free transferability of shares. 
o Nevertheless, contractual restrictions, such as those contained in an agreement 
among shareholders of a closely-held corporation, are valid if deemed reasonable. 
a. “First Option” Restrictions 
Restrictions requiring any shareholder who desires to sell his shares to first offer his shares to the corporation or its other shareholders before offering them to third parties are valid if considered “reasonable”. 
Note 21: Normally, a “first option” provision contains a price at which the selling shareholder must sell or a pricing formula that can be used to determine that 
price. A mere disparity between the contract price and the “fair market” or “intrinsic” value of the shares does not invalidate the price or formula, so long as the parties agreed to that price or formula when entering into their 
agreement. 

 

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What is a right of first refusal restriction?  Are they valid?

 

What is a consent restriction?  When are they enforceable?

Back 168

b. “Right of First Refusal” Restrictions 
Restrictions that prevent a shareholder from selling his shares to a third party unless 
he offers his shares to the corporation or its other shareholders on the same terms as the 
third party is offering are valid if considered “reasonable.” 
c. “Consent” Restrictions 
 A “consent restriction” requires a shareholder to obtain the consent of all the other shareholders or that of the corporation before selling to others. 
 Consent restraints are generally unenforceable if consent can be withheld in the sole and absolute discretion of those holding it. However, a consent restraint where “consent cannot be unreasonably withheld” is generally enforceable. 

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What document permits or sets forth rules about restrictions on the sale of stock?

Back 169

d. Location of Restrictions 
Transfer restrictions may be set forth in the certificate of incorporation, by-laws, or a 
separate agreement (most notably a “shareholders’ agreement”).

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What are closely held corporations?

 

who are directors and officers?

who are the shareholders?

are the shares publically traded/transferrable?

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CHAPTER 11: SPECIAL CORPORATE ENTITIES; LIMITED LIABILITY COMPANIES 
A. SPECIAL CORPORATE ENTITIES 
1. CLOSELY-HELD AND CLOSE CORPORATIONS 
o The terms “closely-held corporation” and “close corporation” are frequently used 
interchangeably to refer to a “mom and pop”-type corporation with the following 
characteristics: 
 It only has a handful of shareholders, most of whom are friends and/or family; 
 Its shareholders are also the directors and officers; 
 Its shares are not publically traded; and 
 Transferability of its shares is typically restricted through provisions in a 
shareholder's agreement. 

 

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What is the liability of the shareholders of a closely held corporation in NY?

Back 171

o Under New York law, the 10 largest shareholders of a closely-held corporation 
are personally liable for all debts, wages, or salaries due and owing to any of its employees (but not independent contractors) if the corporation can’t pay. 
Note 22: Publicly traded corporations, such as IBM, are exempt from this provision.

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What do we mean by a "foreign" corporation?

What does a foreing corp have to do?

What if it doesn't?

What does not constitute doing business in NY?

Back 172

2. FOREIGN CORPORATIONS 
o A foreign corporation is a corporation that is incorporated in a state other than New York. 
o In order to do business in New York, a foreign corporation is required to obtain a certificate of authority to do business in New York. However, failing to do so only prevents the foreign corporation from suing, but not from being sued, in the New York state court system until such time as it registers. 
o A number of actions occurring in New York, such as holding board meetings, maintaining 
bank accounts, and selling through independent contractors, do not constitute doing business in New York for this purpose. 

 

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What is a PC?

What is a requirement for shareholders?

How does malpractice liability work in a PC?

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3. PROFESSIONAL CORPORATION (PC) 
o A professional corporation is a corporation with a purpose that is statutorily limited to the rendering of a professional service (e.g., legal services, accounting services, etc.). 
A shareholder in a professional corporation must be a member of the applicable profession 
o In addition, each shareholder-professional of a PC is only responsible for his own acts of malpractice. He is not responsible for acts of 
malpractice committed by other shareholder-professionals. 
o In all other respects, a PC operates as a typical corporation. 

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What is an S Corp?

What is the point of an S Corp?

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4. S CORPORATION 
o An “S Corporation” designation is strictly a tax designation, and in all other 
respects an S Corporation operates as a typical corporation because it is a typical 
corporation. 
o If a corporation qualifies for and makes an election under Subchapter S of the Internal 
Revenue Code, it will be taxed as a “flow through” or “pass through” entity (similar to a 
partnership or limited liability company). 
o This means that, for income tax purposes, corporate profits and losses are allocated directly to the shareholders on an annual basis based on the number of shares they own. Each shareholder then is responsible for reporting their share of profit or loss on their own personal income tax return. 
o Thus, S Corporations do not pay corporate income tax, which is their main attraction. 

 

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What is an LLC?

What are owners called?

How is it like a partnership and how is it like a corp?

Back 175

B. LIMITED LIABILITY COMPANY (“LLC”) 
• A limited liability company (“LLC”) is a business entity that combines features of a corporation with those of a partnership. In fact, LLCs are often called “incorporated partnerships”. 
• Like shareholders of a corporation, LLC owners (known as “members”) have 
limited liability. 
• Like partners of a partnership, LLC members enjoy pass through taxation and flexibility in managing the entity and raising capital. 
• New York’s Limited Liability Company Law codifies the requirements and default rules relating to a limited liability company. 

 

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What takes precedence in an LLC, the operating agreement or the NY statutory provisions?  Why?

 

What requirement is mandatory in NY?

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1. CREATION 
o An LLC is created by filing articles of incorporation with the state. An LLC 
may adopt an operating agreement that governs any or all aspects of the LLC’s 
affairs. 
o This operating agreement (the LLC equivalent of a partnership agreement) generally takes precedence over contrary statutory provisions, because most statutory provisions are “default” provisions. 
o New York has a mandatory publication requirement for newly formed LLCs. 
Within 120 days after effectiveness of its articles of formation, the LLC must publish a copy of its articles or a notice containing the substance of its articles. Specifically, the notice must be published: 
 Once a week for 6 consecutive weeks; 
 In 2 newspapers located in the county in which the LLC’s office is located. 

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HOw many people does it take to make an LLC?

 

What is a requirement to become a member of an LLC?

 

Who manages an LLC?

 

How do members vote?

 

Who manages when a member doesn't manage?

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2. MEMBERSHIP 
An LLC is not restricted as to the number of members it may have. However, a person cannot become a member of an LLC without the consent of the holders of a “majority 
of membership interests,” unless the LLC’s operating agreement provides otherwise. 
3. MANAGEMENT 
o An LLC may provide for direct management of the LLC by its members (a “member-managed LLC”). Unless otherwise provided by the operating agreement, each member is entitled to vote in proportion to her share of the LLC’s profits. 
o Alternatively, an LLC may provide for centralized management of the LLC by one or more managers who often are (but need not be) members of the LLC (a “manager-managed LLC”). 

 

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LLC members and managers:  limited or general liability?

 

How is it determined who gets how much profit?  What is the default rule?

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4. LIABILITY OF MEMBERS AND MANAGERS 
o A member of an LLC enjoys limited liability, and thus is generally not 
liable to an LLC’s creditors if the LLC can’t pay them back. 
o Additionally, a manager or a managing member of an LLC is not personally liable for 
obligations incurred on behalf of the LLC. 
5. ALLOCATION OF PROFITS AND LOSSES 
o Typically, the operating agreement of the LLC determines the manner in which profits and losses will be allocated among the LLC members. 
o In the absence of such an agreement, profits and losses are allocated and distributions are 
made according to the value of the money or property each member has contributed to the 
LLC.

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What happens when a member transfers his interest in an LLC?

 

How can a transferee become a member?

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6. TRANSFER OF MEMBERSHIP INTERESTS 
o An LLC membership interest is personal property which can be transferred, 
subject to any reasonable restrictions on transfer set forth in the operating agreement. 
o The transfer of a membership interest to another person does not automatically give that person the right to participate in the management of the LLC. Instead, the transferee merely acquires the transferor’s financial or economic rights—namely, the right to share in the LLC’s profits and losses and to receive distributions. 
o Only if holders of a majority of membership interests consent to the transferee 
becoming a member will that transferee gain the management and control attributes of the 
transferred membership interest. 

 

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How and when may a member of an LLC withdraw?

Back 180

7. WITHDRAWAL OF A MEMBER 
A member may withdraw as an LLC member only at the time or upon the happening of the 
events specified in the operating agreement, and then in accordance with the operating 
agreement. 

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Merger of an LLC?  

How does an LLC dissolve?

Back 181

8. MERGER AND DISSOLUTION 
o An LLC may merge with another LLC or another business entity (e.g., partnership, 
corporation). 
o An LLC may dissolve upon the occurrence of various events specified in its operating 
agreement, such as the mutual consent of the members or the withdrawal of any member. 
o In the absence of an operating agreement, the LLC statute provides a laundry list of events of dissolution. 
o Alternatively, any member may petition the court for dissolution if it is not reasonably 
practicable to carry on the business of the LLC in conformity with its articles of organization 
or operating agreement. 

 

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Exam note: when in doubt regarding LLCs, what law can you apply (because the LLC is so similar to this other form of company)?

Back 182

9. DERIVATIVE SUITS 
Although the LLC statute omits any reference to derivative suits, derivative suits by members are permitted by the courts. 
10. WHEN IN DOUBT . . . 
o Because LLCs are so similar to partnerships, questions relating to LLCs can often be answered by applying partnership law. 
o Thus, when in doubt about a question relating to an LLC, apply partnership law.