B Law Test 3

Front 1

Franchisor-Franchisee relationship

Back 1

 Name and reputation is greatest thing franchise has to offer
 Main concern of franchise is that franchisor may take advantage of franchisee
o They can use franchise as test marketing tool, then say franchisee broke some law under franchisor and franchisor takes over successful franchisee
 Other abuse franchisor engages in= if franchisor has company owned stores that compete against franchisee

Front 2

Benefits of corporate form over partnership

Back 2

o Partnership- if someone dies the partnership can continue but first the partnership must allocate what assets/ rights are due to the estate before they can take on any new business- same is true for LLP or LLLP
o Corporation is more stable regarding banking and investing. If someone dies the corporation continues- more protection


 Allocation of money after it dissolves (Partnership)
o 1. Money goes to all other outside creditors- creditors all paid
o 2. Pay back any loans made to partnership
o 3. Internally- pay internal creditors of partnership
o 4. Capital contributions made by partners (get back what you put in)- all of this depends if there is money left/ how far it stretches
o 5. If there is still money left over distribute to remaining partners as income

Front 3

Indicia of corporate form:

Back 3

 Characteristics that if they exist court may say there is now longer LLLP, LLP or LLC (or even PC)
 If more than two of these exist they can be taxed as a corporation (double-tax)
1. perpetual life
2. limited liability
3. centralized management
4. free transferability of ownership (‘stock’) interests

Front 4

Piercing the corporate veil (what are 2 requirements in order to do so?)


Undercapitalization
Commingling of funds
Ultra vires actions
Domination of minority shareholders

Back 4

In order to promote justice and prevent inequity, courts will sometimes ignore the separateness of a corporation and its shareholders by piercing the corporate veil. Primary consequence of this action: a corporation’s shareholders may lose their limited liability. Two requirements exist for a court to pierce the corporate veil:
1. Domination of a corporation by its shareholders (eg. Acting in a way that personally benefits the shareholder or failing to observe corporate formalities or maintaining separate accounting records)
2. Use of that domination for an improper purpose (eg. Defrauding creditors, circumventing a statute, evading an existing obligation)

Undercapitalization (eg. Insufficient insurance for reasonably foreseeable risks/expenses)


Comingling of funds
• Shareholder-managers loot a corporation by paying themselves excessively high salaries or by having the corporation bay their personal credit card bills


Ultra vires actions (eg. Acting contrary to Articles/ByLaws; self-dealing)
• When you don’t follow what is supposed to be in the articles of incorporation or the ByLaws, then you have engaged in ultra vires activity and the court can pierce the corporate veil and hold the individual liable
• If an executive makes a decision that is contrary to article of incorporation or ByLaws, then executive can be held liable


Domination of minority shareholders
• Demanding totally outrageous requirements in order for minority shareholders to access corporate information. Minimum shareholders not allowed to have their issues addressed at shareholders meeting.

Front 5

Business judgment rule; requirements in fulfilling

Back 5

The managers must have a rational basis for believing that the decision is in the best interest of the corporation.
The managers must make an informed decision.
The managers may have no conflicts of interest.
• Definition: A rule protecting business managers from liability for making bad decisions when they have acted prudently and in good faith.
• Requirements in fulfilling the business judgment rule:

Front 6

Shareholder’s Derivative Lawsuit; treatment of any resulting damages/award (e.g. recipient(s) of proceeds; liability of corporation to victorious attorney/firm in lawsuit)

Back 6

• Shareholders bring suit against executives of a corporation because they feel they have acted contrary to the corporation’s purpose (If the stated purpose of the corporation is ‘any lawful purpose,’ then the shareholder’s derivative lawsuit is very difficult to win.)
• If the shareholder’s derivative lawsuit is successful and damages are awarded, the damages ordinarily go to the corporate treasury for the benefit of the corporation. The suing shareholder is entitled only to reimbursement of his reasonable attorney’s fees that he incurred in bringing the action.

Front 7

Elimination of promoter’s liability to third parties/adoption by corporation

Back 7

 If a businessman has a great idea but moves prior to receiving Articles or other necessary documents of corporation. If you are acting on behalf of a nonexistent principle you have liability.


 To escape liability:
o 3rd party must release promoter from liability AND also formerly adopt a contract (after about 1 year it is ratified, then the company does not need to release them)

Front 8

What does not constitute ‘doing business’ within a State?

Back 8

A. If the company has a bank account in that state
B. If there is a shareholders meeting in that state
C. If executives get together and visit that state (not a meeting)
D. Single transaction exception – corporation is not considered to be transacting business if it conducts an isolated transaction within 30 days and the transaction is not in the course of a number of repeated transactions that are similar

Front 9

Certificate of Authority vs. Articles of Incorporation

Back 9

• Certificate of Authority
o If required to qualify to do intrastate business in a state, a foreign corporation must apply for a certificate of authority from the secretary of state, pay an application fee, maintain a registered office and a registered agent in the state, file an annual report with the secretary of state, and pay an annual fee.


• Articles of Incorporation
o The basic governing document of the corporation is the articles of incorporation. The articles are similar to a constitution. They state many of the rights and responsibilities of the corporation, its management, and its shareholders.

Front 10

DeJure v. DeFacto corporate status (3 requirements for Defacto)

Back 10

• DeJure Corporate Status
o A corporation that has compiled substantially with each of the mandatory conditions precedent to incorporation.
o Everything is stated (corporations name etc)- fully official

DeFacto:

There are three requirements for a de facto corporation:
 There is a valid statute under which the corporation could be organized.
 The promoters of managers make an honest attempt to organize under the statute. This requires substantial compliance with the mandatory provisions taken as a whole.
 The promoters or managers exercise corporate powers. That is, they act as if they were acting for a corporation.

o A de facto corporation is treated as a corporation against either an attack by a third party or an attempt of the business itself to deny that it is a corporation. The state, however, may attack the claimed corporate status of the business with a quo warranto action.
o Some small items may be adjusted. The key is that people are acting on behalf of the corporation but they are protected. Business judgment rule applies and liability is limited to personal assets invested in the corporation

Front 11

No self-dealing by corporate executives without company consent

Back 11

 You have idea but don’t want to jump out on own and leave your stable income/ job
 So Person uses company resources to start or get information for other new business venture
 If in the development of the business on the side, any resources of the old business have been used and a person engages in a new business in a similar market as old one it raises red flags. It will be hard though to prove misconduct if the new side business is in a completely different segment or market.
 Best thing= executive gets approval from co-workers to work on business on the side and gets their okay, otherwise people can have stakes/ rights in business if you use company resources
 Weak Argument= co-workers/ old employer says you gained expertise at current job that made side job successful so they should get part- NOT viable argument

Front 12

Definition of security (includes limited partnership interests)

Back 12

• Security- any transaction in which a person invests in a common enterprise reasonably expecting profits derived from the managerial efforts of others

Front 13

Application of exemption from registration statement filing

Back 13

 If it applies to an offering a registration statement MUST be filed and persons that do not file can be held liable, if it does not apply to an offering then it does not need to file a registration statement
 If they are sophisticated/accredited then what is offered may be exempt from security laws
 If all people are of same profession it is exempt from registration statement because it is already involved
 Also exempt if the business is totally intrastate and less than 1.5 million- they are exempt from registration statement being filed because it is already involved in some way in other paper work

Front 14

Due Diligence defense (what are the two parts of due diligence?)

Back 14

 2 parts to due diligence:
o Belief of accurate statement
o Belief that statements you received are complete
 Due Diligence doesn’t apply to an investor, just professionals
 Argument breakdown:
o 1. The injured investor should have been aware of problems in this company, what I did was wrong but investor should have known
o 2. Investor was not in privity of contract (component of law). Professional did not anticipate they were going to use professionals information to get loan from bank or used in any other way. This is a WEAK argument. The company will use it to get articles of corporation or loan- professional is just being naïve if they think company is just using it for their own info/well-being.

Front 15

Means by which professional avoids/escapes liability to users of professional advice

Back 15

• Recipient was not a reasonably foreseeable user of the professional advice
• Recipient could have reasonably discovered information from other public sources revealing the inaccuracy or outdated nature of the professional advice
• Inaccurate/insufficient information relied on was not substantive in investors decision to buy/sell securities;

Front 16

Securities Act of 1933 (two regulatory components/ what does it require?) vs. Securities Act of 1934

Back 16

1933:

o Concerned with protecting investors when securities are sold by an issuer to investors
o The Act has two principal regulatory components
 1: registration provisions—designed to give investors the information they need to make intelligent decisions whether to purchase securities when an issuer sells it securities to the public
 2: liability provisions—impose liability on sellers of securities for misstating or omitting facts of material significance to investors
o Requires that:
 EVERY offering of securities be registered with the SEC prior to any offer or sale of the securities, unless the offering or the securities are exempt from registration. That is, an issuer and its underwriter may not offer or sell securities unless the securities are registered with the SEC or exempt from registration
o Requirements for filing a securities statement under the securities act of 1939
 Identify all persons owning 10% or more of any stock to be offered
 Indicate the general character of the business
 What is the capitalization

1934:

 Insider Trade- no one can have an unfair advantage when it comes to stocks/ trading- prohibits trading on non-public corporate information
 Insider information- people cannot use that information when trading with a person who does not have that info-
 Insiders are people that have a fiduciary relationship with the corporation- employees that know that info about the corporation
 Company must continuously inform SEC on previously issued securities

Front 17

Sarbanes-Oxley Obligations

Back 17

 Desire with SOX to separate auditing activities from advisory/counseling activities
 It is not impossible for accounting firm to do both- they can do accounting and provide oversight as long as it is 1) kept separate and 2) oversight board approves it


 Must be totally separate entities for audit and counsel- separate departments in the same firm- they don’t share any information
 Must have outside disinterested investors as people on the board that approves this- the cannot own shares in company

Front 18

Defenses to insider trading

Back 18

• Damaged party will say that the insider info was not used in any way towards buying stock
 Defense to insider trading is common knowledge- they didn’t act upon insider information
 The insider or the tipper has to derive some benefit from this confidential information- obvious benefit would be if they start investing in the company that the info is about.- not restricted to this though, if person takes them out to ball games/ dinners that could count too