Closely Held Corporations

Front 1

What is Piercing the Corporate Veil?

Back 1

Strips away the corporate form shield of personal liability to allow 3P's to access SH assets (AKA alter ego liability)

Front 2

How often do courts PCV?

Back 2

Very rarely. There is no bright line rule, and each case is treated sui generis on a fact by fact basis

Front 3

D identity matters why?

Back 3

Although contrary to how it should be, Courts seem more likely to PCV when individual SH assets are at risk, and less likely when business assets are at risk.

Front 4

Critics say it should only apply when:

Back 4

1. SH misleads a creditor, causing him to forego a personal guarantee

2. SH siphons off corporate funds so it is undercapitalized to pay debts

Front 5

Three common scenarios:

Back 5

1. Court pierces to get at individual SH assets

2. Court pierces to get at parent company assets

3. Court pierces to get at related entity assets

Front 6

What is the general rule?

Back 6

Courts will only pierce in extraordinary circumstances. Totally CL unless in TX. MBCA says nothing about it.

Front 7

What factors are most important to a court?

Back 7

1. Sham or to perpetrate a fraud

2. Ownership of the Corp. and Identity of the SH's

3. Ignoring Corporate formalities

4. Level of capitalization

5. Contracts vs. Torts

6. One-man corporations

7. Sophisticated Parties

8. Public Policy

Front 8

PCV - 1. Fraud Factor - Is actual fraud required?

Back 8

No. Courts in many JD's say that constructive fraud is sufficient (Dewitt v. Flemming)

UNLESS IN TX: TX has a statute that says P must show actual fraud, and failure to observe formalities is IRRELEVANT

Front 9

PCV - 2. Ownership of the Corporation and Identity of the SH's

Back 9

Courts are much more likely to PCV to get at a parent company's assets than individual SH's

Front 10

PCV - 3. Ignoring corporate formalities (one of 2 most important factors)

Back 10

Failing to comply with statutory requirements is big (e.g. not holding SH meetings, commingling assets, etc.)

BUT - this should only be a factor in contracts cases, not torts (since its unlikely that failure to do so would mislead a 3P by tort)

Front 11

PCV - 4. Level of Capitalization (second most important factor)

Back 11

Standard: was the corporation "grossly undercapitalized for the purposes of the corporate undertaking"

In addition to ammount. other factors:

1. did the SH's make alot of loans to the company? this could be seen as an investment

2. Buying signficant insurance weighs against PCV

3. Did individual D's make personal guarantees?

4. Could the corp. have been profitable?

Critics: this should be irrelevant in a K's case

Front 12

PCV - 5. Contracts v. Torts

Back 12

Courts should be less likely to PCV in K cases is the theory, but in practice courts are more likely to PCV in K's cases

Front 13

PCV - 6. One man Corporations

Back 13

Courts PCV in more than 50% of the cases where one man is the sole SH

Front 14

PCV - 7. Sophistication of Parties

Back 14

If the P was sophisticated, less likely to PCV.

Only relevant in K cases because impossible in tort cases

Front 15

PCV - 8. Policy

Back 15

SCOTUS on PCV:

Appropriateness depends on all 8 factors. Look to direct liability rather than PCV if possible (i.e. parent company actually operating subsidiary)

Front 16

PCV in TX

Back 16

Only state with a PCV statute. Requires:

1. P in a K's case must show actual fraud;

2. Failure to observe corporate formalities is irrelevant

Front 17

Which law governs? (State vs. State)

Back 17

Contracts - Internal affairs doctrine governs

Torts - Law of the state with the "most significant relationship to the occurrence and the parties"

Front 18

Is PCV all or nothing?

Back 18

No. Its determined on a creditor-by-creditor basis and on a SH-by-SH basis

Front 19

Is there an exhaustion requirement in PCV cases?

Back 19

No.

Front 20

What is the general rule of parity among creditors in Corporations?

Back 20

All creditors (3P and SH Creditors) have parity

Front 21

What is the "Deep Rock Doctrine"?

Back 21

A court will subordinate a SH creditor's claim and give 3P creditors priority when equitable principles demand it. (Pepper v. Litton)

AKA "Subordination"

Front 22

What is the standard for subordination?

Back 22

SCOTUS: whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain

A SH creditor should not be able to use insider status to drain the corporation of its assets b/c they stand on a par with 3P's

SH must be able to show GF and inherent fairness toward the corp. and toward 3P creditors (High Standard)

Like Meinhard, if a court cites Pepper, the D will lose

Front 23

What is the payment priority on dissolution of a corporation?

Back 23

1. Secured creditors

2. Unsecured creditors

3. SH's capital investments

4. Distribution of profits

Front 24

Must a secured creditor wait until dissolution to claim its security?

Back 24

No. Upon default, the creditor may foreclose.

Front 25

Is the security claim exclusive? Or can secured creditor also claim other assets?

Back 25

Not exclusive. If the sale of the security does not repay the loan, the creditor does not forfeit its right to the rest. Becomes an unsecured creditor.

Front 26

Successor Liability - If corporation A buys all of the assets of corporation B, does it inherit A's obligations as well?

Back 26

No. But there are exceptions.

Front 27

Name the 4 exceptions to the general successor liability rule:

Back 27

1. Express agreement to assume

2. Where the transaction amounts to a merger or consolidation, the company that remains has assumed all of the second company

3. Where the successor company is a mere continuation or reincarnation of its predecessor (e.g. the same directors, mgmt, SH's, etc.)

4. Fraudulent transaction

Front 28

What rules govern the dissolution of the corporation?

Back 28

14.06 - governs the resolution of known claims against the corp.

14.07 - governs the disposition of unknown claims against the corporation (roughly requires publication in a newspaper, time limit of 3 years)

Front 29

MBCA 6.01 - What required components must the stock of a company have?

Back 29

1. One or more class of shares with unlimited voting rights

2. One or more class of shares that shares in the assets of the company upon dissolution (can be same series that has voting)

Front 30

MBCA 6.01 - If a company wants to issue preferred stock, it must:

Back 30

1. Be set forth in the AOI.

Front 31

What are the two types of preferred stock?

Back 31

1. Dividend preference - preferred stock gets dividend first before CS

2. Liquidation preference - Preferred SH's get paid first upon dissolution

Front 32

What voting rights does common stock have?

Back 32

Unrestricted voting rights on election of directors and all other matters at SH meeting

Front 33

What voting rights does preferred stock have?

Back 33

Generally non-voting (although can be set up differently)

May have contingent voting rights - right to vote if no dividend is paid or the AOI is amended in a way that affects the preference rights of the stock (e.g. creating a new class of preferred shares)

Front 34

How is the dividend preference usually fixed?

Back 34

Its generally a set amount at either a fixed dollar or a percentage of par value (or some other metric)

Front 35

MBCA 6.04 - Does PS have a right to a dividend?

Back 35

No. Just gets preference if and when the corporation declares a dividend.

Front 36

The corollary to the above: Is PS a liability of the company?

Back 36

No. So it does not show up on the balance sheets as a debt or obligation.

Front 37

What is participating preferred stock?

Back 37

Paid twice. Stock that gets preferred dividends and is entitled to participate again in dividends again on par with common stock.

Front 38

What is cumulative participating preferred stock?

Back 38

Cumulative means that if no dividend is paid, the amount is rolled over to when dividends are paid. Participating means you get the double dip.

All cumulative preferred dividends get paid before CS gets paid.

Front 39

Does the MBCA allow upstream conversions? Do most JD's?

Back 39

Yes.

No - most JD's do not allow them.

Front 40

What are redemption rights?

Back 40

Allows the corporation to demand the preferred shares back in return for a specified price.

Most states do not allow CS to have redemption rights, but the MBCA does.

Front 41

What is par value?

Back 41

Represents the minimum issue price (i.e. sets the floor on what stock can be sold for)

Front 42

How does the MBCA treat par value?

Back 42

No need to have it, but company can opt in if it wishes to establish a par value (2.02)

50% of states still have par value requirements.

Front 43

What is watered stock liability?

Back 43

Arises when shares are issued for less than par value - if a SH buys watered stock, they are liable for the difference

Front 44

What types of shares may be "watered"?

Back 44

1. Bonus shares - The SH receives the shares for nothing

2. Discount shares - Shares sold for cash but for less than PV

3. Watered shares - Shares issued for property less than the shares' par value

Front 45

Enforcement of watered stock liability

Back 45

The corporation or its creditors can enforce the statute

Front 46

MBCA 6.02 - Watered Stock

Back 46

A SH who purchases a corporation's shares from the corporation is liable to pay in consideration for which the shares were agreed to be issued

Front 47

MBCA 1969 §19 - Forms of consideration for stock

Back 47

neither promissory notes nor future services count as consideration b/c they represent a promise to pay in the future (might not happen)

Front 48

New MBCA 6.21 - Forms of consideration for Stock

Back 48

Anything goes: any tangible or intangible property or benefit, including cash, promissory notes, K's for services to be performed, etc.

BUT: Corp is allowed to put shares issued for promissory notes into escrow

Front 49

Old Rule - Property for Stock

Back 49

Some JD's, including TX, allowed promissory notes as consideration as long as they were secured by real property (not personal property)

Front 50

New Rule MBCA 6.21 - Property for Stock

Back 50

SH's can pay with property and pretty much anything

Front 51

Old Rule - Valuation of the Property used as consideration

Back 51

Directors had to assign dollar value to the property. Some JD's retain this rule.

Front 52

New Rule MBCA 6.21(c) - Valuation of Property Used as Consideration

Back 52

Directors just have to determine that the consideration is adequate (will be protected by BJR)

Front 53

What states have PV?

Back 53

About half, including TX. MBCA does not.

Front 54

How does TX and (other PV states) treat PV?

Back 54

AOI must have either:

1. a statement of the shares' PV; OR

2. a statement that the shares are without PV

Front 55

What effect does having PV have?

Back 55

May effect the stated capital, capital surplus, may create watered stock liability, may effect the ability of the corporation to make distributions

Front 56

What effect does eliminating PV have?

Back 56

Generally eliminates mandatory capital accounts, eliminates concept of watered stock, and changes the rules of distributions

Front 57

What is the modern trend in PV JD's?

Back 57

Set the PV very very low (nominal) and sell shares for much higher

Front 58

What is the effect of setting a nominal PV in a PV State?

Back 58

1. Avoid watered stock liability (least convincing rationale)

2. Preserve competitive position vis a vis the secondary markets (if the market price drops below the PV, no one will buy from corporation and everyone will go to secondary market)

3. Preserve flexibility in making distributions (most important reason)

Front 59

What is the best way to preserve flexibility to make distributions in a PV state?

Back 59

Set it nominally. This is even better than no PV in a PV state.

Front 60

What is stated capital?

Back 60

(# of shares sold) * (Par Value) = stated capital

Front 61

What is capital surplus?

Back 61

(# of shares sold) * (Price - PV) = capital surplus

Front 62

What is earned surplus?

Back 62

Surplus generated from earnings of the business.

Front 63

In a PV State, when can you make distributions?

Back 63

Out of capital surplus and earned surplus, but never out of stated capital.

Front 64

Old Rule for capital surplus and distributions:

Back 64

In most JD's, including TX, a max of 25% of consideration received could be allocated to capital surplus. Therefore, more flexibility with nominal PV shares than with no PV shares.

Front 65

MBCA 1969 § 21 Rule for capital surplus and distributions:

Back 65

Directors had near total flexibility; entire consideration was considered stated capital UNLESS the directors determined to allocate "any portion of it" to capital surplus

Front 66

MBCA 6.40(c) - Rule for Distributions

Back 66

Eschews PV concept, protects creditors with a 2 prong test:

1. Equity insolvency test AND

2. Balance sheet test

Front 67

What is the equity insolvency test?

Back 67

The corporation will, after paying its distribution, be able to pay its debts as they come due in the ordinary course

Front 68

What is the Balance Sheet Test?

Back 68

After the distribution is made, the corporation's assets exceed its liabilities

Front 69

What are Treasury Shares?

Back 69

Shares the corporation has bought back, either through a redemption or repurchase

Front 70

Is PV relevant for the issuance of Treasury Shares?

Back 70

No. Once the company has bought the stock back, it can then resell it for whatever price it wants.

PV is an issuance concept only, and the sale of Treasury Shares is not an issuance.

Implication: PV has nothing to do with the sale of shares on the secondary market

Front 71

Are Treasury Shares considered issued, outstanding or what?

Back 71

Majority view: treasury shares are issued but not outstanding

(# of treasury shares) = (# of issued shares) - (# of outstanding shares)

As non-outstanding shares, they have no voting rights, dividend rights, and no effect on quorum

Front 72

Are treasury shares considered as an asset?

Back 72

No. Like authorized but unissued shares, not considered an asset.

Front 73

MBCA 6.31- view on Treasury Shares

Back 73

They are authorized but unissued.

Front 74

What is a promissory note?

Back 74

A short term obligation to re-pay

Front 75

What is a bond?

Back 75

Long term obligation that come with a security interest

Front 76

What is a junk bond?

Back 76

Below investment grade debt, generally unsecured (despite the name)

Front 77

What is a zero-coupon bond?

Back 77

A bond purchased at a discounted face price that compensates its holder with repayment of the full face price instead of interest

Front 78

What is a debenture?

Back 78

A long-term unsecured promise to repay

Front 79

What is a thin corporation?

Back 79

a company with a high debt:equity ratio (e.g. 2:1)

Front 80

What are the tax benefits of debt?

Back 80

Interest paid to a lender is tax-deductible under the "ordinary and necessary business" exception. Therefore, companies can use interest payments to help zero out.

Front 81

What is debt reclassification?

Back 81

When SH's loan to a company, courts (and the IRS) will scrutinize and may reclassify it as equity if it is a de facto capital contribution

Front 82

Two types of reclassification?

Back 82

1. Reclassification for priority purposes - creditors will ask courts to reclassify during a bankruptcy proceeding to move the claim back in priority (old rule was that anything higher than 4:1 would be reclassified)

New rule: if there is more equity than debt to the SH's, then the SH's will win

2. Reclassification for Tax purposes - Primary factor:

Did the SH treat it as a regular debt obligation, requiring regular interest payment and principal over time?

Front 83

Old IRS rule that still serves as a guidepost:

Back 83

Guaranteed no re-classification if:

If the corporation's inside debt:equity ratio was less than 3:1, AND

The company's outside ratio was less than 10:1

Front 84

What are the two primary purposes of SEA 1933?

Back 84

1. (Most important) Registration requirement - to ensure that people who sold securities to the public for the first time made full disclosure of all material facts

2. To prevent fraud (which applies regardless of whether the securities have to be registered under the first purpose)

Front 85

SEA 1933 Promotes Disclosure by:

Back 85

1. Requiring the offeror's disclosure sheet to begin with a long statement of "risks to investors" AND

2. SEC will review this disclosure before it is released to the public (gives it teeth)

- However, it is important to note that this is NOT a merits evaluation (i.e. SEC isn't reviewing to determine if its a good investment)

Front 86

Do the exemptions granted by Reg D or any of the other exceptions to the disclosure/registration requirements apply to the anti-fraud provisions of SEA 1933?

Back 86

No. The ant-fraud provisions apply regardless of whether the shares fall within a registration exception

Front 87

What does §5 of the SEA 1933 do?

Back 87

Forces a company that is initially selling shares to the public to register them under § 5

Front 88

What does the SEA 1934 do?

Back 88

It's an omnibus compared to the narrow 1933 Act.

1. Establishes the SEC to regulate securities

2. §14 regulates the proxy voting process

3. Regulates the secondary market in securities (as opposed to 1933, which dealt only with first issuance)

4. Establishes a series of continuous disclosure requirements on corporations required to register under SEA 1934 §12(g)

Front 89

What companies are obligated to provide continuous disclosures?

Back 89

12(g): Corporations that:

1. have shares listed traded on a national exchange, OR

2. with 500 or more SH's of record and more than $10m in assets (DOUBLE CHECK - LIKELY GONE UP)

Front 90

Downside of an IPO:

Back 90

1. Disclosure is the biggest

2. Expense

3. Outside directors (a PHC must have some outside directors)

4. Risk

Front 91

What is a security under §5 of SA 1933?

Back 91

encompasses shares of stock, interests in a LP, or even the purchase of an investment contract (Smith v. Gross)

Front 92

An investment contract constitutes a security when (under Howey):

Back 92

1. the scheme involves an investment of money

2. in a common (shared) enterprise; and

3. with profits to come solely from the efforts of others

(Courts have read this as profit will be generated primarily by the solicitor)

e.g. investors agree to grow worms in a worm farm, profits come from D selling the worms (Smith v. Gross)

Front 93

Is the sale of an interest in an LLC a sale of a "security" under SA 1933?

Back 93

Maybe. Possible resolution:

If you manage like a corp - its a security

If you manage like a partnership -its not

Front 94

What are the implications if an LLC interest is classified as a security?

Back 94

If not registered under SA 1933, civil and criminal liability.

Front 95

Unless it falls into an exception, does SA 1933 §5 require registration of ALL securities?

Back 95

Yes.

Front 96

What are the 3 main exemptions from registration under §5 of SA 1933?

Back 96

1. §3(a) Provides a laundry list of specific securities that are exempt (e.g. securities sold by the fed. government, securities sold only via intrastate commerce, etc.)

2. §3(b) Provides a catchall: offerings of securities that are less than or equal to $5M. However, this is discretionary - SEC may but does not have to allow this exemption

3. §4 Provides a list of exempted transactions: (e.g. a transaction of an issuer not involving a public offering)

Front 97

If you want to use a Regulation D exemption, when do you have to file a Form D?

Back 97

Three times:

1. 15 days after first sale

2. 6 months after first sale

3. 30 days after last sale

Front 98

How does Regulation D fit within the statutory framework of SA 1933?

Back 98

Since §5 technically requires registration of all securities, Reg D gains its authority through the catch-all exemptions in 1933 SA

Front 99

What are Regulation D's 3 Exemptions?

Back 99

1. Rule 504

2. Rule 505

3. Rule 506

Front 100

What is the standard for Rule 504?

Back 100

1. Maximum offering price: $1M or less

2. Maximum number of purchasers: Unlimited

3. Information to be delivered to purchasers: None

4. Limitations on advertising or resale: No limit on advertisements, provided that:

(a) the securities are sold only in states that require the seller to deliver a disclosure document to the purchaser; OR

(b) they're sold in at least ONE such state AND the document is delivered to all purchasers

5. Sophistication requirement: None

Front 101

What are the standards for Rule 505?

Back 101

1. Maximum offering price: $5M

2. Maximum number of purchasers: 35 + an unlimited number of accredited investors

3. Information to be delivered to investors: Yes to all the non-accredited investors

4. Limitations on advertising and resale: Yes

5. Sophistication requirement: None

Front 102

What are the standards for Rule 506?

Back 102

1. Maximum offering price: None.

2. Maximum number of investors: 35 + an unlimited number of accredited investors

3. Information to be delivered to investors: Yes to all non-accredited investors (more stringent info required than 505)

4. Limitation on advertising and resale: Yes - (identical to 505)

5. Sophistication requirement: Issuer must show that every non-accredited investor had the knowledge or business experience necessary to evaluate the risk

Front 103

Rule 501 - What is an "accredited investor"?

Back 103

1. Certain institutions - banks, savings and loans, insurance companies, institutional investors, non-profits with assets over $5M

2. Insiders - directors, executive officers or a general partner of the investor

3. Rich People - Any person who:

(a) individual or joint net worth is over $1M; or

(b) had an individual income in excess of $200K the last 2 years (or $300K if filing jointly)

Front 104

Rule 506 - What is a Public Offering?

Back 104

Rule 506 is a safe harbor re: what constitutes a public offering.

If it fits the exemption, not a PO.

If it does not fit, theres a chance to make a showing with specific facts

Front 105

What is the Freeze Out Problem?

Back 105

Often shares in a CHC have a restriction on transferability, and even if they don't, there is little market for CHC shares. Therefore, freeze out results when:

Minority SH's are at the mercy of the majority, who can prevent them from selling their shares, exercising control, using their votes, and force them to sell their shares below FMV

Front 106

What are Preemptive Rights?

Back 106

The rights that a SH has to buy a % of a new stock issuance that matches up with the % of the shares he owns

Allows a minority SH to prevent dilution re: voting rights and distribution rights

Front 107

Old vs. New Theory of Preemptive Rights

Back 107

Old - Preemptive rights are an inherent property right that attaches to all shares

New - Not a property right; conferred by statute; the AOI may grant or withhold

Front 108

MBCA 6.30 - Are preemptive rights an opt-in or opt-out provision?

Back 108

Opt-in. SH's do not have preemptive rights unless the AOI specifically provides for them.

Front 109

New Texas Law - are preemptive rights opt-in or opt-out?

Back 109

Opt-in. This is also the modern trend for most JD's.

Front 110

MBCA 6.30(b) - in the event that you do opt-in, how do preemptive rights work?

Back 110

1. SH has the right to maintain a proportionate interest in the corp.

Front 111

MBCA 6.30(b) - Can a SH waive their preemptive rights?

Back 111

Yes.

explicit - SH can waive a right, and a waiver in writing is irrevocable.

implicit - SH may waive a right by failing to assert it

Front 112

MBCA 6.30(b) - What presumptions limit the effect of preemptive rights?

Back 112

1. no PR's for shares issued as compensation

2. no PR's for shares issued to satisfy a conversion or option

3. no PR's re: shares issued within 6 months of authorization (1st SH should not have right to own 100% of shares)

4. no PR's for shares issued for anything but cash (i.e. no PR's for property consideration)

Front 113

MBCA 6.30(b) - If you own preferred shares with no voting rights, do you get preemptive rights?

Back 113

No. No preemptive rights for shares of any class of stock

Front 114

MBCA 6.30(b) - If you own common shares, do you get preemptive rights for issuance of preferred shares?

Back 114

No. Presumption that you do not, UNLESS the preferred shares are convertible. Which almost all are. So more like yes.

Front 115

MBCA 6.30(b) - Are all of the above presumptive restrictions subject to change?

Back 115

Yes. The corporation is free to alter these default rules with express statement in the AOI.

Therefore, those restrictions will apply if the company opts-in, unless it explicitly removes them.

Front 116

Are there any limitations on waivers of preemptive rights?

Back 116

Yes. If the majority makes a sham offer in order to induce the minority into not exercising, the minority can argue that he did not truly waive his rights. (Kaskowitz)

Essentially, this is a breach of a fiduciary duty.

Front 117

Do preemptive rights apply when the shares were purchased in exchange for property?

Back 117

No. Cash only.

Front 118

Freezeout Tactics:

Back 118

1. Don't pay dividends

2. Raise majority SH's salary - This allows the majority SH to wait out the lack of a dividend while the minority SH (presumably not an employee) cannot wait

3. Corporation loans money to majority SH - Another way to survive no dividend payments

Front 119

Why is freezeout worse in the CHC context than in a partnership?

Back 119

1. Voluntary dissolution is impossible

2. Judicial dissolution is rare b/c courts are reluctant to get involved due to protections of the BJR

Front 120

Judicial Resolution to the Freezeout Problem:

Back 120

Judges are very reluctant to get involved: the BOD's decision to pay out dividends is protected by the BJR and are totally discretionary.

But, the general rule is that: a failure to pay dividends is a breach of a fiduciary duty when the majority SH's are motivated by personal interest rather than corporate good.

Front 121

What is the modern trend in this area?

Back 121

For judges to employ a per se rule that SH's owe eachother a fiduciary duty. Greater than the duty a BOD owes to the company (Donahue v. Rodd)

This makes it almost on the level of Meinhard

Front 122

What states refuse to institute a per se rule in this area?

Back 122

Maryland and Texas -

Decline to establish a per se rule, say that SH duties to one another depends on the facts & circumstances of the particular case.

Deleware -

Resoundingly denounced the per se fiduciary duty among SH's

MA -

Have a rule that shifts burden to majority to show why it was a legitimate business move.

Front 123

How can a company use redemption as a frezeout method?

Back 123

Corporation redeems shares from majority holders at an inflated price, lowballs redemption offers to minority SH's.

Front 124

What is the remedy if the courts determine that a redemption has been used improperly?

Back 124

Courts will grant the minority SH a reverse preemptive right (allows them to sell back at the same price given to the majority SH's) (Donahue v. Rodd)

Front 125

Is a reverse preemptive right remedy conditional upon having preemptive rights?

Back 125

No.

Front 126

Economist criticism of per se fiduciary duties and reverse preemptive rights:

Back 126

Gives minority too much power; allows them to impose costs on other investors even in the absence of fault

Front 127

What are the options for a minority SH caught in a freeze-out?

Back 127

1. Sell to majority at low price

2. Sell to someone else at FMV (near impossible due to closed market, no one wants to buy a minority position in a CHC)

3. Litigate - costly, unlikely to win

4. Dissolution - the best alternative

Front 128

How to get a voluntary dissolution if you're a minority SH:

Back 128

The MBCA and virtually every state require an affirmative vote from a majority of SH's to dissolve, so this is unlikely.

However, MBCA requires only a majority of the SH's present AT THE MEETING...so you could sneak one in here. Still, most states have not adopted this.

2.

Front 129

MBCA 14.30(a)(2) - How to get an involuntary dissolution if you're a minority SH:

Back 129

Court "may" (not "must") dissolve in 1 of 4 situations

Each of them are rare, and even then courts are reluctant.

Front 130

MBCA 14.30(a)(2) - Situation One

Back 130

1. SH's are deadlocked in management

2. SH's are unable to break the deadlock

3. Irreparable injury is ongoing or threatened

This is rare in CHC freezeouts b/c usually no deadlock since only the minorities are pissed

Front 131

MBCA 14.30(a)(2) - Situation Two

Back 131

The directors are acting in an illegal, oppressive, or fraudulent manner

Front 132

MBCA 14.30(a)(2) - Situation Three

Back 132

1. The directors are deadlocked AND

2. For at least 2 consecutive annual meetings, have not elected new directors

Front 133

MBCA 14.30(a)(2) - Situation Four

Back 133

Corporate assets are being misapplied or wasted

Front 134

What are the Tax Implications on redemption?

Back 134

When a company redeems, SH pays capital gains tax only on the gain (sale price - purchase price)

Front 135

What is the exception to the Tax Rule on Redemptions?

Back 135

When a redemption operates as a dividend.

If the corporation does a proportionate redemption (each SH owns same % after redemption), this is a dividend.

Therefore, in this event - the entire amount (not just gains) received is subject to FIT

Front 136

MBCA 6.40 - Who has discretion to declare a dividend?

Back 136

It is entirely up to the BOD

Front 137

MBCA 6.40(c) - When can a company make a distribution?

Back 137

If it meets the equity insolvency test and the balance sheet test.

Front 138

What is the equity insolvency test?

Back 138

The corporation would still be able to pay off debts as they come due in the ordinary course of business

Front 139

What is the Balance Sheet Test?

Back 139

The corporations total assets would not be less than:

1.the sum of its total liabilities plus

2. (unless the AOI specifies otherwise) the amount that would be needed to pay those with preferential rights (superior to those receiving the distribution) upon dissolution

Front 140

MBCA 1.40(6) - What is a distribution?

Back 140

A direct or indirect transfer of money or other property (except its own shares) or incurrence of indebtedness by a corporation to or for the benefit of its shareholders in respect to any of its shares

Front 141

What does in respect of its shares mean?

Back 141

Essentially that you are being paid due to your ownership of the stock or in relation to your ownership of the stock.

e.g. a payment of salary is in relation to services rendered

Front 142

MBCA 1.40(6) - What forms may a distribution take?

Back 142

1. Dividend

2. Purchase, redemption, or other buyback of its shares

3. Distribution of indebtedness;

4. Or otherwise

Front 143

Would a promissory note given to a SH in respect of his shares qualify as a distribution?

Back 143

Yes.

Front 144

If Corporation A distributes shares of Corporation B to its SH's on a 1-for-1 basis for each share of Corporation A that they own, is this a distribution?

Back 144

Yes. However, remember that the MBCA excludes transfers of the company's OWN shares.

Front 145

If the company does not have money on hands right now, but anticipates it, can they meet the equity insolvency test?

Back 145

Yes.

Front 146

Who can directors rely on to provide information to make this judgment?

Back 146

officers, lawyers, accountants, or anyone with specialized knowledge.

Front 147

For the purposes of the balance sheet test, does the corporation treat liquidation preferences owned to senior securities as a liability?

Back 147

Yes. For this test only. Must include amount that you would have to pay upon dissolution as a liquidation preference to preferred holders.

Front 148

MBCA 6.40(e) - When do these tests have to be satisfied?

Back 148

Depends on the type of distribution being authorized.

Front 149

MBCA 6.40(f) - If a corporation pays a distribution by taking on indebtedness to a SH, how is that debt treated?

Back 149

It is at parity with the company's other general unsecured creditors. But the "Deep Rock" doctrine can circumscribe this.

Front 150

MBCA 6.40(e) - Timing of meeting the test for stock buybacks (redemptions, etc.)

Back 150

The effect of a distribution is measured as of the earlier of :

1) the date the money or other property is transferred; or

2.) the date that the SH ceases to be a SH with re: to the acquired shares

Front 151

MBCA 6.40(e) - Timing to meet test for distribution of indebtedness

Back 151

The effect is measured "as of the date the indebtedness is distributed"

Front 152

MBCA 6.40(e) - Timing to meet test for dividends

Back 152

1. If the payment occurs within 120 days after the date the distribution is authorized, the effect is measured as of the date of the authorization

2. If the payment occurs more than 120 after authorization, effect is measured as of the date the payment is made

Front 153

What is the TX Law on Distributions?

Back 153

Applies the same two tests, with some slight variations.

Front 154

TX Balance Sheet Test

Back 154

Corporation's net assets - stated capital

net assets = assets minus liabilities

Front 155

Therefore, a TX corporation can make a distribution in the amount of: (assuming its met insolvency test)

Back 155

[(Assets) - (Liabilities)] - (PV * # of shares outstanding)

Front 156

Under the traditional view, an impermissible SH agreement was:

Back 156

An agreement to decide in advance how they would vote as directors

Front 157

What is the modern trend on SH agreements in CHC's?

Back 157

It makes sense to allow in a company where the same people who own the shares are running the company, due to the limited market for shares in a CHC (Galler)

Front 158

MBCA 8.01(b) - What is the limitation on this general rule that states that "all corporate powers shall be exercised by the BOD"?

Back 158

MBCA 7.32 - Added in 1992 to underscore the modern trend.

Provides that SH's in CHC's are free to encroach on the authority of the BOD or even dispense with it altogether

Front 159

What case was the turning point on SH agreements?

Back 159

Galler v. Galler

Front 160

What is the standard in Galler?

Back 160

In a CHC, as long as the agreement is designed to accomplish something practical, it should be enforceable:

1. no public injury

2. No complaining minority interest

3. No prejudice to the creditors

Front 161

What is an integrated closed corporation statute?

Back 161

Statutes adopted by some states that allow CHC's to impinge on the authority of the BOD provided they put the state and public on notice

Front 162

Does TX have a closed corporation statute?

Back 162

Yes.

Front 163

How do you get the benefits of a closed corporation under Texas Law?

Back 163

A simple statement in the COI: "this is a closed corporation"

Front 164

Are there maximums on the number of SH's for these rules to apply?

Back 164

In some states. DE has such a rule.

Front 165

Are these statutes exclusive? (if a CHC is a CHC but fails to make the election, should they be excluded from the rule?)

Back 165

DE - Exclusive

NY - Not exclusive. Corp. should be able to amend its AOI and elect it, so long as no one is harmed by the agreement

TX - Unresolved.

Front 166

MBCA 7.32 - Are SH agreements that deprive the BOD of some or all of its power enforceable?

Back 166

Yes. So long as it fits under the statute.

However, these agreements are only enforceable if it is a CHC. (7.32(d))

Front 167

Common Law Approach to Removing Directors

Back 167

SH's could only remove a director for cause; some sort of actionable misconduct. Directors had due process to rights in removal proceedings

Front 168

MBCA 8.08 - How can SH's remove directors?

Back 168

With or without cause, unless the AOI provide that they may only be removed for cause

Front 169

MBCA 8.08 - If a corporation provides in its bylaws that it can remove directors only for cause, can it?

Back 169

No. Can still remove without cause. Has to be in the AOI.

Front 170

MBCA 8.08(b) - If a director is elected by one class of SH's, who can remove him?

Back 170

Only that group that elected him.

Front 171

MBCA 8.10 - If a vacancy occurs on the BOD, who can vote to fill it?

Back 171

Unless provided otherwise in the AOI,

Either the SH's or the BOD

Front 172

MBCA 8.10(b) - if the vacancy was held by a director elected by a particular voting group, who can vote to fill it?

Back 172

Only that group that elected him

Front 173

Who is entitled to vote a particular share?

Back 173

The record owner. Not the beneficial owner.

However, the beneficial owner can go to a court to force the record owner to give him a proxy

Front 174

MBCA 7.07 - When does the corporation determine who is the record owner?

Back 174

On the record date. This may not be more than 70 days prior to the meeting.

If the record date is not set in the bylaws or AOI, the BOD can determine it.

Front 175

MBCA 7.05 - What and when are SH's entitled to receive notice of a meeting?

Back 175

Entitled to receive notice of: the date, time, and place of a meeting no fewer than 10 days before or more than 60 days before.

If its an unscheduled meeting, notice must contain information re: meeting's purpose

Front 176

MBCA 7.06 - Can SH's agree to waive notice? If so, how?

Back 176

Yes, but it must be in writing.

Implied waiver - if SH shows up to the meeting and participates w/out objection

Front 177

What is a quorum?

Back 177

The minimum number of shares, not shareholders, that must be represented at a meeting in order to take action

Front 178

MBCA 7.25(a) - What constitutes a quorum?

Back 178

A majority of the shares of the voting group entitled to vote on the matter, unless the AOI provide otherwise

Front 179

MBCA 7.25(b) - Once a quorum is established, can SH's break it by leaving?

Back 179

No. Quorum remains effective until the end of the meeting

Front 180

MBCA 7.27 - How can you change the quorum requirements?

Back 180

Only through the AOI.

Front 181

MBCA 7.27 - Can you raise and lower quorum requirements? If so, how much?

Back 181

Raise - Can raise all the way to unanimous

Lower - Not in the text, but in the comments. No floor, theoretically can have no quorum

Front 182

Under TX Law, can you lower quorum requirements? If so, how much?

Back 182

Yes - but it may not be lowered to less than 1/3

Front 183

MBCA 7.25(c) - How are votes tallied in a meeting? Do abstentions count?

Back 183

In an vote for anything but the election of the BOD:

Vote is approved if the votes cast in favor of the matter are greater than the votes cast against it. Yays outnumber the nays.

(i.e. Abstentions DO NOT count)

Front 184

Texas Rule - How are votes tallied and do abstentions count?

Back 184

Matter only passes if it gets a majority of the votes cast, including abstentions.

(i.e. abstentions count as no votes)

Front 185

MBCA 7.04 - How can SH's take action without a meeting?

Back 185

If there is unanimous consent.

Front 186

DE Rule - How can SH's take action without a meeting?

Back 186

So long as there is consent from the minimum number of shares needed to take action on that issue at a SH meeting.

Front 187

MBCA 7.28 - How are directors elected?

Back 187

Unless provided for in the AOI, directors are elected by a plurality of the votes cast by the shares entitled to vote.

Default rule is straight voting.

Front 188

What is a plurality?

Back 188

The most yes votes (i.e. not necessarily a majority)

Front 189

MBCA 10.22 - In a PHC, can a corporation alter its voting to majority in its bylaws?

Back 189

Yes.

Front 190

MBCA 7.28 - Can company amend its bylaws to provide for cumulative voting?

Back 190

No. It must be adopted in the AOI.

Corollary - if a company opts in under its AOI to have cumulative voting, it takes an amendment to the AOI to go back

Front 191

Texas Rule - What is the default for electing directors?

Back 191

After 09/01/2003 - SH's do not have the right to cumulate voting unless the corporation opts in

Front 192

What is straight voting?

Back 192

A SH has one vote per share, per slot in the election and the number of votes a SH may cast in favor of a particular director is capped at the number of shares he owns.

Example - F has 100 shares, Director slots A, B, and C are open. F has 100 votes for A, 100 for B, and 100 for C.

Front 193

What is cumulative voting?

Back 193

A SH has one vote per share per slot up for election, and the SH may cumulate those votes and allocate them among the slots however he wants

Ex. F has 100 shares, and A, B, and C are up for election. F can vote all 300 for A, or 150 for A and B, or however.

Front 194

Advantages of Cumulative voting

Back 194

It is democratic in that it allows SH's with minority interests to get seats on the board. Increases diversity of view points on the board, reduces risks of conflicts of interest on the board.

Front 195

Disadvantages of Cumulative Voting

Back 195

Elects partisan members to the board, which is not how a BOD is supposed to function (should rep all interests). Creates friction on the BOD, which promotes inefficiency. MGMT may be less likely to take needed risks.

Front 196

What is the critical formula for the number of shares that a SH needs to be able to elect "n" directors?

Back 196

SH > n*( S/ (D+1))

SH = number of shares the SH has

n = number of directors to be elected

S = total number of shares voting

D = number of directors to be elected (not the total number of directors on the BOD if it has a staggered board)

Front 197

MBCA 8.06 - How may the company provide for a staggered board? How many classes of directors may there be?

Back 197

Company may provide for a staggered board in which different classes of directors are elected at different times. Must do so in AOI.

The corporation can create 2 or 3 classes.

Does not specify a minimum number of directors needed to create such a board

Front 198

Old Rule - How many directors did a company need to have in order to create a staggered BOD?

Back 198

Only allowed for staggered boards if the company had nine or more directors

Front 199

Most states require what for staggered boards?

Back 199

Only if there are 3 or more directors and only if the company does not have cumulative voting

Front 200

Effect of staggering:

Back 200

Frustrates cumulative voting by making the denominator larger; functions as a shark repellant, making takeovers more difficult

Front 201

Other ways to frustrate cumulative voting:

Back 201

1. Increase the numerator by increasing the number of shares voting

2. Freeze out the minority director by denying access to information, refusing to appoint to committees, etc.

3. Eliminate cumulative voting

4. Reincorporate in a JD that does not have cumulative voting

Front 202

How would you go about eliminating cumulative voting?

Back 202

Must make an amendment to the AOI.

Front 203

MBCA 10.03 - What is required to amend the AOI?

Back 203

Depends. If it is one of the listed things under 10.05 (change name, etc.), you just need BOD approval.

For most substantive changes, you need BOD and SH approval. (10.03)

Front 204

MBCA 8.08(c) - If the company authorizes cumulative voting, what is required to remove a director?

Back 204

A director may not be removed if the number of votes against her removal would be sufficient to elect her under cumulative voting.

The number of votes is counted at the meeting where the removal is held, not where the election was held.

Front 205

MBCA 7.28(d) - what is required for a SH to exercise their cumulative voting rights?

Back 205

1.) The meeting notice or proxy statement must conspicuously state that cumulative voting is authorized; OR

2.) A SH with the right to cumulate must give the company notice 48 hours before the meeting. At that point, all SH's in that voting group would have right to cumulate.

Front 206

Does cumulative voting apply to anything other than the election of directors?

Back 206

No. That's why it is only discussed in 7.28.

Front 207

MBCA 7.30 - How does a voting trust work?

Back 207

1. SH turns over their shares to a trustee, and only the trustee has the right to vote those shares. Trustee must provide a list of members in the VT.

2. In exchange, the SH receives a voting trust certificate, which is freely transferrable and confers all rights except the right to vote.

Front 208

MBCA 7.30 - Is there a time limitation on voting trusts?

Back 208

No. Up until recently, you had a 10 year limit. Not anymore.

Front 209

MBCA 7.31 - What is a Voting Agreement?

Back 209

It's just a contract among SH's as to how they will vote in an election. Totally enforceable.

Front 210

Were voting agreements enforceable under the traditional view?

Back 210

Yes. It was always acceptable to agree in advance how SH's would vote. What was impermissible was SH agreements that agreed in advance how they will run the company.

Front 211

What is proxy voting?

Back 211

Process of a SH letting someone else vote his shares

Proxy refers to both the instrument and the person doing the voting

Front 212

MBCA 7.22 - What is the standard term of a proxy?

Back 212

11 months, unless provided otherwise in the AOI (i.e. its only good for one SH meeting)

Front 213

MBCA 7.22 - a proxy is revocable unless:

Back 213

1. The appointment form states that it is irrevocable, AND

2. The appointment is coupled with an interest

Front 214

What does "coupled with an interest mean"? What are some examples?

Back 214

1. The person who is given the right to vote the proxy also has a stake in the corporation

2. Examples (per 7.22): proxy has agreed to purchase the shares, proxy giver has pledged the shares to the proxy as collateral for a loan, the proxy is the beneficial owner, an employee, a party to a voting agreement created under 7.31

Front 215

MBCA 7.22(f) - When does an irrevocable proxy become revocable?

Back 215

When the interest with which it is coupled is extinguished (e.g. employee gets fired, beneficial owner sells shares, etc.)

Front 216

Is the MBCA list of interests for irrevocability exclusive? Is New York's?

Back 216

MBCA - No. List is non-exclusive. (e.g. CEO could be an irrevocable proxy, even though not listed)

NY - Yes

Front 217

To whom does the trustee of a voting trust owe a fiduciary duty?

Back 217

"for whose benefit the VT was created"

Front 218

When do issues arise concerning Voting Trusts? (Abercrombie)

Back 218

When courts decide that it is unenforceable because it appears to be a voting trust (as opposed to a voting agreement); but did not comply with the statutes

This was more of an issue when time limits were strictly enforced in VT's.

Front 219

In establishing whether the court will treat it as a voting trust, which 3 factors matter?

Back 219

1. Voting rights of stock are separated from other aspects of ownership

2. Voting rights are intended to be irrevocable for a period of time

3. the primary purpose of the grant is to acquire voting control of the corporation

Front 220

Example of an unenforceable trust:

Back 220

Group of SH's arrange to vote together to take control of the company, they appoint an agent to vote their shares collectively, and turn over their shares in exchange for a receipt. The agreement was not time-restricted, so therefore it did not comply with a statute because in effect it was a VT (Abercrombie)

Front 221

Examples of agreements that were determined not to be VT's:

Back 221

1. appointment of an arbitrator (Ringling)

2. creation of a class of voting shares (Lehrman)

3. Creating a class of shares with no rights other than to elect a director (this is a disembodied right to vote, and it is enforceable)

Front 222

MBCA 6.27 - What is a buy/sell agreement?

Back 222

Form of CHC Shareholder agreement that restricts a SH's ability to transfer shares to someone else

Front 223

Types of Buy/Sell Agreements

Back 223

1. Cross-Purchase agreements - If one SH dies, retires, or wants out, the other SH's are obligated to buy him out

2. Stock redemption agreement - If one SH wants out, the corporation is required to redeem his shares (note: this would be a distribution, and therefore must satisfy 6.40)

3. Right of first refusal - SH must go to company before seeking 3P investors to buy his shares

4. Right to approve of 3P purchaser

Front 224

Valuation is a big issue in buy/sell agreements; what are some of the methods?

Back 224

1. Choose a fixed sum (dangerous)

2. Formula

3. Book value - this is dangerous b/c it may be higher or lower than FMV; may bear no relationship to actual value

4. Market value - difficult to assess in a CHC

5. Have the assets appraised - this can be expensive and controversial re: who gets to appoint the appraiser

6. Little Kid Dessert Method - One person sets price, the other gets to choose whether to buy or sell at that price (this is good, but assumes only 2 SH's with equal interest in the company)

Front 225

MBCA 6.27 - What is the one limitation on buy/sell agreements?

Back 225

Must be reasonable.

Front 226

MBCA 6.27 - Do you have to provide for buy/sell agreements in the AOI?

Back 226

No. Could be agreed to in bylaws, AOI, or just a SH Agreement between SH and company (or other SH's)

Front 227

What is an example of an unreasonable buy/sell agreement?

Back 227

A restriction barring all transfers to anyone

Front 228

MBCA 6.27 - Is the buy/sell agreement enforceable against the SH or the transferee?

Back 228

Both. Valid against the SH, so long as reasonable.

Valid against the transferee so long as:

1. it is reasonable; AND

2. the restriction is note conspicuously on the front or back of the certificate

Front 229

MBCA 6.27 - Is there any way to enforce a buy/sell agreement against a transferee if the restriction is not included on the certificate?

Back 229

Yes. It is enforceable if the transferee has actual knowledge of the restriction.

Front 230

What is one downside of a ROFR?

Back 230

It chills the SH's ability to find 3P investors, since they know company will come back and buy it if its at a decent price

Front 231

Judicial dissolution at common law - When will courts dissolve a company?

Back 231

If the dissolution will be beneficial to the stockholders or members and not injurious to the public

Front 232

Judicial dissolution at common law - What factors weigh in favor of dissolution?

Back 232

1. SH's and directors are deadlocked; there's so much hostility that nothing can be accomplished

2. Where the Sh has no other options to get out of the company (e.g. a minority SH)

3. If a fair buy-out offer would not work as a remedy

Front 233

Judicial dissolution at common law - What factors weigh against dissolution?

Back 233

1. Corporation is profitable during the litigation

2. Dissolution is not a neutral remedy - e.g. if there are 2 SH's, and only one knows how to run the business and could go out and start another business, this is prejudicial toward the other SH

Front 234

What is the modern remedy for oppression, dissension, and deadlock?

Back 234

Even where not authorized by statute (as in TX), many courts will fashion a buy-out remedy

Front 235

What is oppressive conduct? (Davis v. Sheeren)

Back 235

Conduct by a majority SH that substantially defeats the expectations that, when objectively viewed, were reasonable under the circumstances and were central to the minority owner's decision to invest

Front 236

MBCA 8.24 - What is a quorum of the BOD?

Back 236

A majority of the fixed number of directors

Front 237

MBCA 8.24 - May a quorum be higher or lower? If so, can you provide for that in the bylaws, or does it have to be in the AOI?

Back 237

1. Higher - permissible, unlimited ceiling

2. Lower - permissible, but cannot be lower than 1/3 (as opposed to SH quorum, which has no floor)

3. It may be amended in the AOI OR the Bylaws (note: a SH quorum may only be amended in the AOI)

Front 238

MBCA 8.24 - What does it mean that a majority of the "fixed" number equals quorum? If one member resigns, does the quorum change?

Back 238

This means that it must be a majority of the directors that are fixed in the AOI, not a majority of those currently in office.

If a director resigns, the quorum should not change (e.g. if 4 directors serving, and 1 resigns, the quorum is still 3)

Front 239

MBCA 8.24 - Can a director break quorum by leaving before the vote?

Back 239

Yes. As opposed to SH meetings, quorum is taken at the time of the vote.

TX Law is unclear on this point.

Front 240

MBCA 8.24 - assuming a quorum is present, what is the standard for reaching a "yes" vote? Does this apply to the number of directors in office or the number of directors present at the time of the vote?

Back 240

1. Affirmative vote by a majority

2. Of the directors present (not of those in office)

Front 241

MBCA 8.24 - When is a director presumed to have voted yes?

Back 241

If he is present at the meeting.

Front 242

MBCA 8.24 - What three things negate the presumption that the director voted "yes"?

Back 242

1. If the director objects at the beginning of the meeting

2. his dissent or abstention in the matter is taken down in the minutes

3. he delivers written notice to the presiding officer of the meeting of his abstention or dissent prior to the end of the meeting or immediately thereafter

Front 243

MBCA 8.24 - May a director who voted "yes" in the meeting still preserve his right to dissent by providing it thereafter?

Back 243

No. If he votes yes, its a yes.

Front 244

What is the majority view (and Old MBCA view) on quorum required to fill a vacancy if one director resigns?

Back 244

Any vacancy may be filled by a majority vote of the remaining directors.

Front 245

MBCA 8.10 - What is the MBCA's position on quorum requirements to fill a vacancy?

Back 245

It is required unless the remaining directors constitute fewer than a quorum. (i.e. only if a quorum is impossible)

Front 246

What case is related to this?

Back 246

Gearing v. Kelly

Front 247

MBCA 8.05 - What is the term of an initial director? What is the term of every other director?

Back 247

1. Expires at the first SH's meeting where directors are elected

2. Expires at the next meeting after their election (annually); UNLESS the board is staggered

Front 248

MBCA 8.05(e) - in the event that there is a tie and the SH's cannot agree on a successor, what happens to the serving director's term?

Back 248

It continues until the tie is broken and a successor is elected