TABLE OF CONTENTS
I.
PARTNERSHIPS .......................................................................................................................................... 1
A. Basic Nature of a Partnership..................................................................................................................... 1
B. Compared to a Joint Venture ..................................................................................................................... 1
C. Formation of a Partnership ........................................................................................................................ 1
D. Effects of the Partnership Relationship ....................................................................................................... 2
E. Management: ........................................................................................................................................... 3
F. Authority / Agency .................................................................................................................................... 3
G. Liability of Partners to 3rd Parties ............................................................................................................... 3
H. Partnership Property ................................................................................................................................. 3
I. Transfer of Partnership Interest .................................................................................................................. 3
J. Dissolution of Partnership .......................................................................................................................... 4
II. GENERAL CHARACTERISTICS OF A CORPORATION ................................................................................... 4
A. Separate Legal Entity ................................................................................................................................ 4
B. Limited Liability ........................................................................................................................................ 4
C. Continuity of Existence.............................................................................................................................. 4
D. Management and Control .......................................................................................................................... 4
E. Corporate Powers...................................................................................................................................... 4
F. Constitutional Status of Corporations .......................................................................................................... 5
III. REQUIREMENTS FOR FORMATION: ARTICLES OF INCORPORATION ........................................................ 5
A. Mandatory Provisions of the Articles of Incorporation – § 14A:2-7 ............................................................... 5
IV. ISSUANCE OF SHARES – TYPES OF SECURITIES ....................................................................................... 5
A. Classes of equity Shares............................................................................................................................ 5
B. Issuance of Shares ................................................................................................................................... 6
V. ULTRA VIRES AND CORPORATE POWERS .................................................................................................. 6
A. Ultra Vires ................................................................................................................................................ 7
VI. PRE-INCORPORATION TRANSACTIONS BY PROMOTERS .......................................................................... 7
A. Promoter Defined...................................................................................................................................... 7
B. Fiduciary Responsibilities ........................................................................................................................... 7
C. Liability - General Rule .............................................................................................................................. 7
D. Flow Chart ............................................................................................................................................... 8
VII.
DEFECTIVE INCORPORATION ............................................................................................................... 8
A. De Jure Corporation .................................................................................................................................. 8
B. De Facto Corporation ................................................................................................................................ 8
C. Corporation By Estoppel ............................................................................................................................ 8
D. New York & New Jersey............................................................................................................................. 9
VIII.
PIERCING THE CORPORATE VEIL ..................................................................................................... 9
A. Generally ................................................................................................................................................. 9
B. Post’s Division of Doctrine, Tests, and Factors............................................................................................. 9
C. Factors Examined When Piercing a Corporation Held By Individual Shareholders ........................................... 9
D. Factors Examined When Piercing a Parent / Subsidiary Structure, Making the Parent Liable for Subsidiary .....10
IX. STRUCTURE OF A CORPORATION – ALLOCATION OF POWERS ............................................................... 10
A. Traditional Structure of a Corporation........................................................................................................10
B. Powers of Shareholders ............................................................................................................................11
C. Powers of Directors ..................................................................................................................................11
D. Powers of Officers....................................................................................................................................11
X. BOARD OF DIRECTORS ............................................................................................................................. 11
A. Election...................................................................................................................................................11
B. Number of Directors.................................................................................................................................12
C. Duration of Term .....................................................................................................................................12
D. Resignation .............................................................................................................................................12
E. Removal of Directors ................................................................................................................................12
F. Filling Vacancies.......................................................................................................................................12
G. Director’s Meetings ..................................................................................................................................12
H. Act of the Board ......................................................................................................................................12
I. Committees .............................................................................................................................................13
XI. OFFICERS.................................................................................................................................................. 13
A. Definition ................................................................................................................................................13
B. Right to Hire and Fire:..............................................................................................................................13
C. Authority to Act For the Corporation..........................................................................................................13
XII.
SHAREHOLDER ACTION ...................................................................................................................... 14
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A. Meetings .................................................................................................................................................14
B. Quorum ..................................................................................................................................................14
C. Vote Required..........................................................................................................................................14
XIII.
OFFICERS’ & DIRECTORS’ FIDUCIARY DUTIES .............................................................................. 14
A. Duty of Care............................................................................................................................................14
B. Business Judgment Rule (BJR) ..................................................................................................................15
C. Duty of Loyalty ........................................................................................................................................16
D. Executive Compensation ..........................................................................................................................17
E. The Corporate Opportunity Doctrine ..........................................................................................................17
XIV.
CLOSE CORPORATIONS – GENERALLY ............................................................................................... 18
A. What Is a Close Corporation .....................................................................................................................18
B. Significance of Close Corporation Status ....................................................................................................18
C. Fiduciary Duty of Shareholders .................................................................................................................18
XV. SHAREHOLDER VOTING AGREEMENTS, VOTING TRUSTS AND CLASSIFIED STOCK ............................... 18
A. Voting Agreements ..................................................................................................................................18
B. Voting Trust ............................................................................................................................................18
C. Classified Stock and Weighted Voting ........................................................................................................19
XVI.
AGREEMENTS RESTRICTING THE BOARD’S DISCRETION .................................................................. 19
A. Problem Generally ...................................................................................................................................19
B. Present View ...........................................................................................................................................19
C. New Jersey View (14A:5-21(2)) ................................................................................................................19
XVII.
SUPER-MAJORITY VOTING AND QUORUM REQUIREMENTS ........................................................... 19
A. New Jersey View: ....................................................................................................................................19
XVIII.
SHARE TRANSFER RESTRICTIONS .................................................................................................. 20
A. Why Used................................................................................................................................................20
B. Enforcement............................................................................................................................................20
C. Various Techniques ..................................................................................................................................20
D. Notice and Consent: ................................................................................................................................20
E. Valuation: ...............................................................................................................................................20
F. Requirement of “Reasonableness” .............................................................................................................20
XIX.
RESOLUTION OF DISPUTES, INCLUDING DISSOLUTION (14A:12-7) ................................................ 21
A. Dissension and Deadlock ..........................................................................................................................21
B. Freeze Out & Oppression ..........................................................................................................................21
C. Dissolution ..............................................................................................................................................21
D. Alternatives to Dissolution: ......................................................................................................................21
XX. SHAREHOLDER DERIVATIVE SUITS ......................................................................................................... 21
A. What is a Derivative Suite: .......................................................................................................................21
B. Distinguish Derivative for Direct Suit .........................................................................................................22
C. Requirements of a Derivative Suit .............................................................................................................22
D. Demand on Board / Early Termination Based on Board or Committee Recommendation................................23
E. Settlement of Derivative Suits ..................................................................................................................23
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I.
PARTNERSHIPS
A. Basic Nature of a Partnership
1. A partnership is an association of two or more persons to carry on a business as co-owners for
profit. [UPA § 202(a)]
2.
A lawful partnership cannot be formed for non-profit purposes.
B. Compared to a Joint Venture
1. A joint venture is an association of two or more member, agreeing to share profits, however, it is
usually more limited than a partnership (i.e. formed for a single transaction and is usually not the
complete business of its members). The rights a liabilities of partners and joint venturers are usually
the same.
C. Formation of a Partnership
1. Partnership by Contract: Since a partnership is a voluntary association, there must be an
express or implied agreement in order to form a partnership
a) Formalities: If the partnership is to continue beyond one year, the agreement must be in
writing since it comes within the Statute of Frauds.
b) Duration: If no term is specified, then the partnership is terminable at the will of any
partner.
c) Capacity to Become a Partner: Persons must have the capacity to contract. Some
states hold that corporations cannot be partners.
d) Consent of Other Partners: A prospective partner must have consent of all the other
partners. [UPA § 401(i)]
e) Intent of the Parties: Where there is any question, the intent of the parties involved is
determined from all of the circumstances. [see UPA § 202]
(1) Sharing of Gross Returns alone is not enough [UPA § 202(c)(2)]
(2) Sharing of Profits of a business is prima facie evidence that he is a partner in
the business, but no such inference shall be drawn if such profits were received in
payment [UPA § 202(3)];
(a) as a debt by installments or otherwise,
(b) for services as an independent contractor or wages or other compensation
to an employee
(c) rent to a landlord,
(d) as an annuity to a widow or representative of a deceased partner,
(e) as interest on a loan, and
(f) as the consideration for the sale of a good-will of a business
(3) Fenwick v. Unemployment Comp. Comm: Owner of a beauty shop entered into a
profit-sharing agreement with an employee to retain her.
(a) Held: Mere existence of a profit sharing agreement, although strong
evidence, is not dispositive in determining whether a partnership exists.
(b) Factors to be considered include: intentions of the parties when entering
into an agreement, the right to share in the profits as well as the obligation to
share the losses, ownership and control of the business property, control over
management, and the rights on dissolution.
(4) Lenders Are Not Partners: lenders do not become partners simply b/c they get
compensation. A person whom receives a share of profits of a business is presumed to
be a partner in the business, unless the profits were received in payment of a dept.
[UPA § 202(c)(3)(i)
2.
Partnership by Estoppel
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a) Liability of Alleged Partner: One who holds herself out to be a partner, or who
expressly or impliedly consents to representations that she is a partner, is liable to any third
person who extends credit in good-faith reliance on such representations [UPA § 308(a)]
b) Liability of Partners who Represent Others to be Partners: If a member of a
partnership represents to a third party that a non-member is actually a member, and the third
party relies on this representation is good faith, than that non-member will be held as an
agent of the partnership an the partnership is liable accordingly. [UPA § 308(b)]
3.
Partnership Agreement
a) UPA provides the default rules for partnerships but they can be modified / amended by
contract. [UPA § 103]
b) The following may not be modified by contract [UPA §103(a)]:
(1) Exempt partners of personal liability
(2) Dissolution at will
(3) Waiver of fiduciary duty of loyalty
(4) Unreasonably reduce duty of care.
(5) More… see statute.
D. Effects of the Partnership Relationship
1. Profits and Losses: Each partner, in the absence of agreement, shares profits and losses equally
[UPA § 401(b)]
a) Profits and losses are shared in the same proportions (e.g. if there is an agreement for a
60/40 profit sharing, the same ratio applies to the sharing of losses).
2.
Fiduciary Obligations of Partners
a) Duty of Loyalty and Duty of Care [UPA § 404(a)]
b) Duty of Loyalty: Duty of Loyalty is limited to the following:
(1) to account to the partnership and hold as trustee for it any property, profit or
benefit derived by the partner in the conduct / winding up of partnership business.
[UPA § 404(b)(1)]
(2) To refrain from dealing w/ the partnership in conduct having an adverse interest.
[UPA § 404(b)(2)]
(3) To refrain from competing befpre the dissolution of the partnership. [UPA §
404(b)(3)]
c) Duty of Care: Duty of care in conduct of business is limited to refrain from engaging in
grossly neg., or reckless conduct, international misconduct, or a knowing violation of the law.
[UPA § 404(c)]
d) Good Faith / Fair Dealing: The general standard is good faith and fair dealing. [UPA §
404(d)]
e) Self Interest: Merely acting for slef interest is not a breach of fiduciary duty. [UPA §
404(e)]
f) Lend Money: A partner may lend money to and transact other business with the
partnership. [UPA § 404(f)]
3. Duty of Disclosure: Each partner and the partnership shall furnish to a partner and to the legal
representative of a deceased partner:
a) Without Demand any info. concerning the partnership’s business and affairs reasonably
required for the proper exercise of the partners rights; and
b) On Demand, any other info. concerning the partnership within reason.
c) Meinhard v. Salmon: Co-adventurers are treated as partners. And they owe each other an
affirmative duty of “utmost good faith and loyalty,” while the enterprise is ongoing.
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E. Management:
1. Equal Rights: All partners have equal rights in management (even if sharing of profits is
unequal). [UPA § 401(f)]
2. Majority Rule: Any difference arising as to ordinary matters relating to the partnership may be
decided by a majority of the partners. [UPA § 401(j)]
a) Deadlock: If there is a deadlock, then the status quo wins (i.e. whom ever wants to
change the least wins).
F.
Authority / Agency
1. All are Agents: All partners are agents of the partnership for carrying on in the usual way the
business of the partnership. [UPA § 301(1)]
a) National Biscuit Company v. Stroud
2. Limits on Authority: By agreement, the partners can limit or restrict the authority of one or
more partners in the partnership. [UPA § 303(2)]
3. Apparent Authority: If a third party thinks a person has authority to bind the partnership, they
bind the partners even if from the perspective of other partners, the acting member had no real
authority to do so. There are three defenses to a claim of apparent authority:
a) Partner was not acting within the scope of partnership business and was not
authorized by the other partners [UPA § 301(2)]
b) Third party had actual knowledge that partner had no authority. [UPA § 301(1)]
c) If the partnership filed a Statement of Partnership Authority that limits the ability of
any partner to act. If this is on file, partners are going to be exempt from liability. [UPA §
303(a)(2)]
G. Liability of Partners to 3rd Parties
1. Generally: Partners are held to be joint and severally liable. Each partner is an agent of the
other. Any acts taken by a partner in the ordinary course of business will bind the others [UPA §
301(1)]
a) Acts taken by a partner outside the scope of the ordinary course of business will bind the
partnership only if the act was authorized by the other partners [UPA § 301(2)]
2. Admissions and Representations : The partnership is charged with the admissions and
representations of any partner concerning partnership affairs, when they are made in the scope of her
actual, implied, or apparent authority. [UPA § 303(1)]
3.
Tort Liability
a) If one partner cause a loss to a 3rd party, all the partners are liable. [UPA § 305(a)]
b) If one partner breaches a duty as a trustee for a third party, the whole partnership is
liable [UPA § 305(b)]
c)
MUST ASK:
(1) What is the nature of the act in relation to the nature of the business? (e.g.
ordinary)
(2) Was it reasonably foreseeable that the partner would act in a certain way.
H. Partnership Property
1. Property acquired by a partnership is property of the partnership and not of the partners
individually. [UPA § 203]
I.
Transfer of Partnership Interest
1. Default Rule: Must be unanimous consent because the risk of harm is so great. This can be
amended by agreement. [UPA 401(i)]
a) Partnership interest is not really transferable to the same extent as is a corporate interest.
All the partners must consent to the admission of a new partner. A partner may “assign” his
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partnership interest, but this does not make the transferee a partner. Instead, the transferee
merely obtains limited economic rights.
2. Not Co-Owner of Partnership Property: A partner is not a co-owner of partnership property
and has no interest in partnership property which can be transferred, either voluntarily or
involuntarily. [UPA § 501
3. Partner’s Transferable Interest In Partnership: The only transferable interest of a partner in
the partnership is the partner’s share of the profits and losses of the partnership and the partner’s
right to receive distributions. The interest is personal property. [UPA § 502]
4. Transfer of Partner’s Transferable Interest: A partner may transfer all, or part of, his interest
in the partnership. This does not by itself cause the partner’s disassociation or a dissolution of the
partnership. Also the transferee is NOT entitled to participate in the management or conduct of the
partnership. [UPA § 503(1-3)]
J.
Dissolution of Partnership
1.
Events Causing Dissolution And Winding Up of Partnership:
a) A partner gives notice of his express will to withdraw [UPA § 801(1)]
b) Partnership was constructed for a definite term or particular undertaking. [UPA § 801(2)]
c)
Occurrence of an event agreed to in the partnership agreement [UPA § 801(3)]
d) Occurrence of an event that makes it unlawful for the partnership to continue [UPA §
801(4)]
e) Judicial Determination [UPA § 801(5 + 6)]
2. Partnership After Dissolution: The partnership may continue after dissolution only for the
purpose of winding up. [UPA § 802]
3.
Settlement of Accounts: The basic steps in dissolution are as follows [UPA § 807:
a) If the partnership is going to dissolve, first all of the partnership assets are sold off and
the profits go to all the partnership [i] creditors, including partners who are creditors.
b) Second, if there is any money left over after all the assets are sold and all the creditors
are paid off, then that money goes to repay the [ii] partners capital contribution. Thus, the
partners themselves are treated as subordinated creditors of the partnership.
c) Third, the losses of the partnership that remain, (after all these creditors are paid off
(outside and inside creditors) whether they are operating losses (debts still owed to outside
creditors) or capital losses are shared among the partners according to their share of profits.
II. GENERAL CHARACTERISTICS OF A CORPORATION
A. Separate Legal Entity
1. A corporation is a separate legal entity (created by the law of a specific state), apart from the
individuals that may own it (shareholders) or manage it (directors, officers, etc.). Thus, the
corporation has legal “rights” and “duties” as a separate legal entity.
B. Limited Liability
1. The owners (shareholders) have limited liability; debts and liabilities incurred by the corporation
belong to the corporation and not to the shareholders.
C. Continuity of Existence
1. The death of the owners (share holders) does not terminate the entity since share can be
transferred.
D. Management and Control
1. Management is centralized with the officers and directors. Each is charged by law with specific
duties to the corporation and its shareholders. The rights of the corporate owners (shareholders) are
spelled out by the corporate bylaws.
E. Corporate Powers
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1.
F.
As a legal entity, a corporation can sue or be sued, contract, own property, etc.
Constitutional Status of Corporations
1. Wheeling Steel Corp. v. Glander  SCOTUS held that corps. are persons under Due Process and
Equal Protection clauses of 14A. Corps. are not, however, citizens under 14A or Article IV.
III.REQUIREMENTS FOR FORMATION: ARTICLES OF INCORPORATION
A. Mandatory Provisions of the Articles of Incorporation – § 14A:2-7
1.
NJ Articles of Incorporation MUST State
a) Corporate Name
b) Corporate Purpose
(1) May simply state that the corporation may engage in any business in which a
corporation is legally allowed to engage in NJ.
c)
Aggregate Number of shares
d) Classes of Shares / Number of Shares in a Class / Rights of each of the shares of each
class.
e) If share are created, set forth the Board’s authority to divide shares into classes and to
change rights belonging to a class.
f)
Any provisions not in violation of the law.
g) Address of Corporation’s registered office and name of registered agent.
h) List of directors
i)
Name and address of incorporators
j)
The duration of the corporation if not perpetual
k) If the Certificate of Incorporation is to be effective on a date subsequent to the date of
filing  the effective date of the certificate
IV. ISSUANCE OF SHARES – TYPES OF SECURITIES
A. Classes of equity Shares
1. Common Stock: Stock in a corporation in which dividends (payouts) are calculated upon a
percentage of net profits, with distribution determined by the board of directors. Usually holders of
common stock have voting rights. These are distinguished from preferred stock in which the profits
are a predetermined percentage and are paid before the common shareholders who gamble on higher
profits, and collectively have voting control of the corporation.
2. Preferred Stock: A class of shares of stock in a corporation which gives the holders priority in
payment of dividends (and distribution of assets in case of dissolution of the corporation) over owners
of "common" stock at a fixed rate. While the assurance of first chance at profits is a psychological and
real benefit, preferred stock shareholders do not participate in higher dividends if the corporation
makes large profits, and usually cannot vote for directors.
a) Usually Non-voting: Preferred stock is usually non-voting stock, except, it can have
voting rights if:
(1) There is conditional clause in the voting agreement
(2) There is a non-payment of dividends
(3) If the corporation is facing a major decision (e.g. merger, dissolution).
b) Reasons For Issuing Preferred Stock
(1) Contingent Voting Rights: Normally preferred stock carries only contingent
voting rights (i.e. voting rights accrue only when dividends are not paid or on major
corporate transactions). This means that preferred stock does not dilute voting control
that resides in the common shareholders.
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(2) Fixed Percentage Annual Dividend: The disadvantage to preferred stock is that
this interest (dividend) paid on the preferred stock is not tax deductible to the
corporation.
(3) Less Risk: While preferred stock carries with it less risk, there is also chance for a
greater payoff with common stock.
3. Cumulative Preferred Stock: Preferred stock on which dividends accrue in the event that the
issuer does not make timely dividend payments. Most preferred stock is cumulative preferred.
4.
Convertible Preferred: Stock that allows one to convert it from Preferred to Common stock.
a) NOTE: stock is not convertible upstream (common to convertible).
5.
Redeemable Stock: Shareholders can ask the corporation to buy back the stock.
6.
Purchasable Stock: The company can ask shareholders to sell back the stock.
B. Issuance of Shares
1. Par Value: If shares have a par value, the corporation may not sell the share for less than this
par value. This rule protects both the corporation’s creditors, and also other shareholders
a) New Jersey: Under NJ law, par value is an opt in provision. If no par value is declared in
the articles then all shares have no par value and no stated capital shall be required to be
maintained. (14A:7-8.1(1))
b) Watered Stock Liability: If shares are issued for less than their par value, creditors will
often be allowed to recover against the stockholder who received the cheap stock (usually
called “watered stock”).
2. Stated Capital: The aggregate of the par values of all issued shares constitutes the "stated
capital" of the corporation. Any excess received for the issuance of par value shares is "capital
surplus."
a) Par Stock: If the stock has par value, stated capital is equal to the number of shares
outstanding times the par value of each share.
b) No Par Stock: If the stock is “no par” stock, stated capital is an arbitrary amoun that the
board assigns to the stated capital account. (This amount is never more than the shareholders
paid for their stock when they originally bought it, but is otherwise whatever the directors
decide it should be when the stock is issued).
c) NOTE: Because of the use or normal par value, in many corporations there is a lot of
capital surplus and relatively little stated capital.
3. Capital Surplus: Capital Surplus is everything in the corporation’s “capital” account other than
stated capital. (i.e. Excess received for the issuance of par value shares). “Paid in” surplus,
“revaluation surplus” and “reduction surplus” are the main types of capital surplus.
4. Earned Surplus / Retained Earnings: Earnings not paid out as dividends but instead reinvested
in the core business or used to pay off debt. also called Accumulated Earnings or Un-appropriated
Profit.
5. Dividends: A dividend is a cash payment made by a corporation to its common share holders pro
rata. It is usually paid out of the current earnings of the corporation, and thus represents a partial
distribution of profits.
6. Preemptive Rights: A preemptive right is the right of a shareholder to subscribe to a pro-rate or
proportionate share of any new issuance of shares that might operate to decrease her percentage
ownership in the corporation.
a) At Common Law: At common law the shareholders were deemed to have an inherent
right to preempt new stock offerings
b) New Jersey: Under NJ law, a right of preemption is an opt-in provision.
c) Remedies: There are several remedies available to protect a shareholder’s preemptive
rights:
(1) Damages: Damages are calculated on the basis of the difference between the
offering price of the new shares and the cost of acquiring the shares in the market.
6
(2) Equitable Remedies: If the shares are not available in the market, the
shareholder with preemptive rights may sue for specific performance, compelling the
corporation to issue the additional shares necessary for the shareholder to retain a
proportionate interest. When shares have not yet been issued, shareholder may get an
injunction against issuance of the shares in violation of her preemptive rights.
d) Shareholders Vote to Eliminate Preemptive Rights: Generally, courts tend to permit
a majority of the shareholders to eliminate preemptive rights by amendment.
V. ULTRA VIRES AND CORPORATE POWERS
A. Ultra Vires
1. Classic Doctrine
a) Traditionally, acts beyond the corporation’s articles of incorporation were held to be “ultra
vires” and were unenforceable against the corporation or by it.
2. Modern Abolition
a) Modern corporate statutes have generally eliminated the ultra vires doctrine.
3. New Jersey 14A:3-2
a) No act or transaction of a corporation will be invalidated for being outside its power or
capacity, HOWEVER, such lack of power or capacity may be asserted.
VI. PRE-INCORPORATION TRANSACTIONS BY PROMOTERS
A. Promoter Defined.
1.
A “promoter” is one who takes initiative in founding and organizing a corporation.
B. Fiduciary Responsibilities
1. Duty to Co-Promoters: Prior to incorporation, promoter owe a fiduciary duty to each other. In
effect, they are partners in the formation of the corporation. In this regard they must disclose all
relevant matters and deal fairly with each other.
2. Duty to the Corporation: Promoters also owe a fiduciary duty to the corporation (duty of care,
duty of loyalty)
C. Liability - General Rule
1. Promoter is personally liable on a pre-incorporation contract absent an agreement otherwise. How
& Assoc. v. Boss (S.D. Iowa 1963)
a) Even if corporation adopts the contract, the promoter is bound – unless there has been a
novation in which the corporation assumes the liability of the promoters
b) The promoter may be absolved of liability as a result of adoptive conduct by the
corporation.
c)
A promoter may be absolved of liability through a novation.
(1) Novation: A three-party agreement whereby the corporation agrees to assume the
contract liability of the promoter(s) with the consent of the third party who agrees to
release the promoter(s) from the contract.
2. If the promoter enters into a contract in the corporation’s name, and the promoter knows that the
corporation has not yet been formed (but the other party does not know this), the promoter will most
likely be liable under the contract.
3. If the contract entered into by the promoter on behalf of the corporation recites that the
corporation has not yet been formed, the liability of the promoter depends on what the court finds to
be the parties intent.
a) Never formed or immediately defaults: If the corporation is never formed, or is formed but
then immediately defaults, the promoter will probably be liable.
b) Formed and Then Adopts: If the corporation is formed, and then shows its intent to take
over the contract (ie adopts the contract), then the court MAY find that both parties intended
7
that the promoter be released from liability. Absent a finding of such and intent, the promoter
will still be liable even if the corporation adopts the contract.
D. Flow Chart
1.
Was the K signed before the corp. was formed?
a) NO  no promoter liability
b) YES  Q2
2.
Was the K in the name of the to-be-formed corp.?
a) NO  no promoter liability
(1) If promoter signed in his own name, the promoter is liable
b) YES  Q3
3.
Did the other party (non-promoter) know the corp. was not formed?
a) NO
(1) If promoter knew, promoter will almost certainly be liable if corporation is not
formed or defaults
(2) If neither party knew, analyze as a defective corporation, promoter may escape
liability if his ignorance of the corporations status was reasonable.
b) YES  Q4
4.
Was the corporation ever in fact formed?
a) NO  Promoter will most likely be liable.
b) YES  question of parties intent, promoter may still be liable.
VII.
DEFECTIVE INCORPORATION
A. De Jure Corporation
1. A corporation that has complied strictly with all of the mandatory provisions for incorporation
cannot be attacked by any party (even the state) on the grounds that it should not be a properly
recognized corporation. What is mandatory and what is “directive” is a matter of judicial construction
of the state’s incorporating laws.
B. De Facto Corporation
1. A body of common law that indicates that even when a corporation has not complied with all of
the mandatory requirements to obtain de jure status, it may be complied sufficiently to be given
corporate status vis-à-vis third parties (although not against the state).
a) Requirements:
(1) There is a state statute under which one can incorporate.
(2) A colorable attempt to incorporate (eg submitted paperwork to SOS)
(3) A good faith actual use or conduct of business as though a corporation existed.
2.
Takes perspective of incorporators – i.e. Did you act like you were a corporation?
C. Corporation By Estoppel
1. A creditor who deals with a business as a corporation, and who agrees to look to the corporation’s
assets rather then the shareholders’, will be estopped from denying the existence of the corporation.
Questions asked when determining Corporation By Estoppel are:
a) To what degree did the corporation attempt to comply with the requirements of
incorporation?
b) Did the plaintiff deal with the entity as a corporation and how much knowledge did the
plaintiff have about the entity’s legal posture?
8
c) Did the defendants whom the plaintiff seeks to hold personally liable know that no
corporate entity existed?
2.
Takes perspective of 3rd party – i.e. Did you act like you were dealing with a corporation?
a) Cranson v. IBM Corp. – IBM sold typrewrites through Cranson whose AOI had not yet been
filed. When IBM tried to recover for unpaid debt, court applied Corp. by Estoppel and found
that IBM did business with Cranson as if he were a corporation and relied on the company’s
credit, not Cranson’s, in making the sale.
D. New York & New Jersey
1. Neither NY or NJ has adopted a statute which provides that if you represent yourself as acting on
behalf of a corporation, you are joint and severally liable.
VIII.
PIERCING THE CORPORATE VEIL
A. Generally
1. Piercing the Corporate Veil is a metaphor to describe the cases in which a court refuses to
recognize the separate existence of a corporation despite compliance with all of the formalities for the
creation of a de jure corporation. Consequently, the court may hold some or all of the shareholders
personally liable for the corporation’s debts.
2.
The is only used for closely held corporations, not for public corporations.
B. Post’s Division of Doctrine, Tests, and Factors
1. Doctrine
a) Alter Ego
b) Instrumentality
2. Test
a) Equity and Justice
3.
Factors – see below.
C. Factors Examined When Piercing a Corporation Held By Individual Shareholders
1. Tort v. Contract (“voluntary creditor”): Courts are more likely to pierce the veil in a tort case
(where creditor is involuntary) than in a contract case (where creditor is voluntary).
2. Fraud: Veil piercing is more likely when there has been a grievous fraud or wrongdoing by the
shareholders (e.g. siphoning of profits, undercapitalization).
3. Inadequate Capitalization: Most important, veil piercing is most likely if the corporation has
been inadequately capitalized. Most courts, however, do not make inadequate capitalization alone
enough for veil piercing.
a) Zero Capital: When the shareholder invests no money whatsoever in the corporation,
courts are especially likely to pierce the veil, and may require less of a showing on the other
factors than if the capitalization was inadequate but non-zero.
b) Siphoning: Capitalization may be inadequate either because there is not enough initial
capital, or b/c the corporation’s profits are systematically siphoned out as earned. If
capitalization is adequate, however, and the corporation then has unexpected liabilities, the
shareholders’ failure to put in additional capital will generally not be considered inadequate
capitalization.
4. Failure of Formalities: The court is more likely to pierce the veil if the shareholders have failed
to follow corporation formalities running the business. Examples include:
a) Shares are never formally issued
b) Directors’ meeting are not held
c)
Shareholders co-mingle personal and company funds.
d) Records are not kept.
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5. Summary: In nearly all cases of veil piercing, at least two of the above factors must be present
for the court to pierce the veil; the most common combination is probably inadequate capitalization
plus failure to follow corporate formalities.
6.
Cases
a) Baatzv. Arrow Bar (1990) – Mere failure upon occasion to follow all of the corporate
formalities prescribed by will not justify disregarding the corporate entity.
b) Radaskewski v. Telecom Corp. (1992) – Adequate insurance can be considered by the
court in lieu of adequate capital.
c) Fletcher v. Atex Inc. (1995) – To prevail on alter-ego claim between P and S, plaintiff
must show that the two corps acted as a single economic entity.
D. Factors Examined When Piercing a Parent / Subsidiary Structure, Making the Parent Liable for
Subsidiary
1. No Liability Generally: The general rule is that the parent is not liable for the debts of the
subsidiary.
2. “Dominance” of subsidiary not enough: The fact that the parent may in some sense dominate
the affaires of the subsidiary will not by itself be enough to give rise to veil piercing. So long as the
degree of control by parent over subsidiary is within the bounds usually found in corporate America,
creditors will probably not be able to attack the parent’s assets. Actions manifesting dominance may
include:
a) P drains excess cash from the S,
b) P demands veto power of S’s significant decisions.
c)
3.
P exercises some degree of control over S’s actions.
Factors Leading to Piercing:
a) P and S fail to follow separate corporate formalities for the two corporations.
(1) E.g. Both have the same board and do not hold separate directors’ meetings.
b) P and S are operating pieces in the same business, and S is undercapitalized.
c)
The public is mislead about which entity is operating which business
d) Assets are intermingled between P and S
e) S is operated in an unfair manner (e.g. forced to sell at cost to parent).
f)
Single Economic Entity Theory (Alter Ego):
(1) As the Delaware courts summarize the idea, only if the two companies operate as
a “single economic entity” (alter ego) will the veil generally be pierced, assuming that
there is no fraud on creditors.
IX. STRUCTURE OF A CORPORATION – ALLOCATION OF POWERS
A. Traditional Structure of a Corporation
1. Shareholders
a) The shareholders act principally by (1) electing and removing directors; and (2) approving
or disapproving fundamental or non-ordinary changes (e.g. mergers)
2. Directors
a) The directors manage the corporations business. They formulate the policy and they
appoint officers to carry out that policy.
3. Officers
a) The corporation’s officers administer the day-to-day affairs of the corporation, under the
supervision of the board
4. Modification
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a) The traditional allocation of powers usually may be modified by the corporation where
appropriate. This is often done in the case of closely held corporations.
B. Powers of Shareholders
1.
Directors
a) Election: Shareholders normally elect the directors at the annual meeting of
shareholders. (14A:5-2)
b) Vacancies: Shareholders usually have the right to elect directors to fill vacancies on the
board (14A:6-5(3)), but the board of directs also has this power (14A:6-5(1)).
c) Removal: At common law, shareholders had little power to remove a director during his
term of office. Today, most statutes allow the shareholders to remove directors even without
cause (14A:6-6(1))
(1) NOTE: If a director is part of a class for which the duration he will hold office is
specified in the articles of incorporation, he may NOT be fired w/o cause. (14A:66(2)(d))
2. Articles and Bylaws
a) The shareholders can amend the articles of incorporation or the bylaws (14A:2-9(1)
regarding bylaws; 2-9(3) regarding articles)
3. Fundamental Changes
a) The shareholders get to approve or disapprove of fundamental changes not in the ordinary
court of business (e.g. mergers, sales of substantially all of the company’s assets, or
dissolution) (14A:11-1(1)(a); 11-1(1)(b); 11-1(1)(c); dissolution 14A:12-4(2))
C. Powers of Directors
1. Shareholders Can’t Give Orders: Shareholders usually cannot order the board of directors to take
any particular action.
a) Shareholder may, however, include provisions in the articles to restrict the board’s
management powers. (14A:5-21(2))
2. Supervisory Role: The board does not operate the corporation day to day. Instead, it appoints
officers, and supervises the manner in which the officers conduct the day-to-day affairs.
D. Powers of Officers
1. The officers are appointed by the board, and can be removed by the board. The officers carry out
the day-to-day affairs.
a) NOTE: Generally shareholders cannot appoint officers; this would by bypassing the boards
authority. It maybe the case, however, that a provision in the articles which specifically allow
shareholders to appoint officers will be held as valid if unanimously agreed to by ALL
shareholders. (14A:5-21(2))
X. BOARD OF DIRECTORS
A. Election
1. Elected By Shareholders: Members of the board of directors are always elected by the
shareholders.
2. Straight v. Cumulative: The vote for directors may either be “straight” or “cumulative.” In NJ,
cumulative voting is an opt-in provision (14A:5-24(2)).
a) Straight Voting: Shareholders get one vote for each share held. The majority of those
voting maintain power.
b) Cumulative Voting: In cumulative voting, a shareholder may aggregate his votes in
favor of fewer candidates then there are slots available. The purpose of cumulative voting is to
assure minority shareholders of representation on the board. (14A:5-24(2))
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c) Removal & Cumulative Voting: If cumulative voting is authorized, a director may not
be removed if the number of votes that would have been sufficient to elect him under
cumulative voting is voted against his removal. (14A:6-6(2)(a))
B. Number of Directors
1. The number of directors is fixed in the bylaws, subject to any provision in the articles. In NJ, the
board must consist of at least one member. The bylaws specify the number of directors or the range
(minimum and maximum) of the number of directors. (14A:6-2)
C. Duration of Term
1. In NJ, no class of director may have a term less than 1 year or greater than 5 years. (14A:64(1)).
D. Resignation
1.
Directors may resign at any time.
E. Removal of Directors
1. With or Without Cause: NJ providers that directors may be removed by a majority vote of
shareholders, either with or, baring a provision in the articles, without cause. (14A:6-6(1))
a) NOTE: If a director is part of a class for which the duration he will hold office is specified in
the articles of incorporation, he may NOT be fired w/o cause. (14A:6-6(2)(d))
2. Removal By Board: In NJ, the articles or bylaws may provide that the board shall be able to
remove directors for cause and suspend directors pending a determination that cause exists. (14A:66(3)).
F.
Filling Vacancies
1. Board or Shareholders: Vacancies on the board may be filled by the board (14A:6-5(1)) or by
the shareholders (14A:6-5(3)).
2. Classes of Stock: The articles of incorporation may give each separate class of stock the power
to elect one or more directors. (14A:6-4(2))
3. Holdover Director: A director holds officer not only for the term for which he is elected, but until
his successor is elected and qualified. A director serving beyond the end of his term is called a
“holdover” director.
G. Director’s Meetings
1. Regular v. Special: There are two types of board meetings: regular and special. A regular
meeting is one which occurs at a regular interval (e.g. monthly). All other meetings are special. The
frequency of regular meetings is usually specified in the bylaws.
2. Notice: No notice is necessary for a regular meeting. Prior notice is required for special meetings
or as per the bylaws (14A:6-10(2))
3. Quorum: The board may only act if a quorum is present. The quorum is a majority of the total
directors in office unless otherwise provided by the articles or bylaws. (14A:6-7.1(3))
a) Present at the vote: The quorum must be present at the time the vote is taken.
H. Act of the Board
1. Majority Vote: The board may take action only by a vote of a majority of the directors present at
the meeting or as required by the articles or bylaws (14A:6-7.1(4))
a) Higher Number: In NJ, the articles or bylaws may set a higher percentage than a
majority for all or certain board actions (14A:6-7(4)).
2. Requirement for Meeting: The board may normally take action only at a meeting, not by
individual action of the directors.
a) Exceptions:
(1) Unanimous Written Consent: NJ allows directors to act without a meeting if
they give their unanimous written consent to the proposed corporate action. (14A:67.1(5))
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(2) Ratification: If the board learns of an action taken by an officer, and the board
does not object, the board may be deemed to have “
ratified” this action (depending on an examination of the intent of the parties). Also,
the board may be estopped from dishonoring the act. In either case, the result is as if
the board had formally approved the action in advance.
3. Objection by Director: A director may disassociate
himself from board action by filing a written dissent, or by making an oral dissent that is entered in
the minutes of the meeting. This will shield the director from any possible liability for the corporate
action (14A:6-13)
I.
Committees
1. The full board may appoint various committees. Generally, a committee may take any action
which could be taken by the full board, however, committees generally cannot take actions outside the
normal course of business such as selling off all or most of the corporations assets, merging with
another corporation, or dissolution.
XI. OFFICERS
A. Definition
1. “Officer” describes only the more important executives of the corporation, typically those
appointed directly by the board of directors. It is up to the board or the bylaws to determine what
officers there will be and the extent of their Actual Authority.
B. Right to Hire and Fire:
1. Officers can be both hired and fired by the board. Firing can be with our without cause (and can
occur even if there is an employment contract, though the officer can then sure the corporation for
breach).
C. Authority to Act For the Corporation
1. Agent of Corp.: The officer is an agent of the corporation, and his authority is therefore analyzed
under agency principles. An officer does ot have the automatic right to bind the corporation. Instead,
one of the following four doctrines must usually be used to find that the offer could bind the
corporation on particular facts:
2. Express Actual Authority: Express Actual Authority is given when the corporation’s bylaws or a
resolution adopted by the board specifically provide for an officer to conduct himself in a certain
manner or perform a specific act.
3. Implied Actual Authority: Implied Actual Authority is authority that is “inherent in the office.”
Usually, it is authority that is inherent in the particular post occupied by the officer. Implied Actual
Authority is often the authority to take an action to achieve a responsibility designated by Express
Actual Authority.
a) The board may always remove Implied Actual Authority by specifically prohibiting a certain
action of type of action.
4. Apparent Authority: Apparent Authority exists if the corporation gives observes the appearance
that the agent is authorized to act as he is acting. There are two requirements:
a) The corporation, by acts other than those of the officer, must indicate to the world that the
officer has authority to do the act in question; and
b) The plaintiff must be aware of those corporate indications and rely on them.
(1) President: In the case of a president, apparent authority will often flow merely
from the fact that the corporation has given him that title – he will then have apparent
authority to enter into ordinary course arrangements.
5. Ratification: Under the doctrine of ratification, if an officer acts outside the scope of his authority
and this action is learned of by an officer who has actual authority to conduct such an action, and that
officer either expressly affirms it or fails to disavow it, the corporation may be bound (facts specific).
a) Usually, P will have to show that the corporation either received benefits under the
contract, or that P himself relied to his detriment on the existence of the contract.
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XII.
SHAREHOLDER ACTION
A. Meetings
1. Annual Meetings: NJ requires that an annual meeting of the shareholders be held in accordance
with the articles or bylaws, or, if now time is specified therein, at noon on the first Tuesday of April.
(14A:5-2)
2. Special Meeting: Corporations may also hold a special shareholders’ meeting. A special meeting
is any meeting other than the regularly scheduled meeting. In NJ, special meetings may be called by
the president or the board, or by such offers, directors, or shareholders as may be provided in the
bylaws. Also, a holder of more that 10% or all shares may apply to the Supreme Court to call a special
meeting. (14A:5-3).
B. Quorum
1. Generally: For a vote of a shareholders’ meeting to be effective, there must be a quorum
present. In NJ, this must be a majority of the outstanding shares. However, the percentage required
for a quorum may be reduced or increased if provided in the articles or bylaws. (14A:5-9)
C. Vote Required
1. Majority Vote Wins: Once a quorum is present, NJ states that the shareholders will be deemed
to have approved of the proposed action only if a majority of the votes cast are in favor or the
proposed action, unless a greater plurality is otherwise required by the articles or another section of
Title 14A. (14A:5-11(1))
2. Breaking Quorum: Once a quorum is present, the quorum is deemed to exist for the rest of the
meeting, even if the shareholders leave.
3. Written Consent: NJ allows shareholders to act by written consent without a meeting if all
shareholders who would have been able to vote consent to do so in writing. (14A:5-6).
XIII.
OFFICERS’ & DIRECTORS’ FIDUCIARY DUTIES
A. Duty of Care
1. Basic Standard: Directors and members of any committee designated by the board shall
discharge their duties in good faith and with that degree of diligence, care and skill which ordinarily
prudent people would exercise under similar circumstances. (14A:6-14(1))
a) No Accommodation Directors: There is no such thing as a accommodation or “dummy”
director. If a person sits on a board, he automatically (and non-waivably) bears the burden of
acting with due care.
b) Egregious Cases: However, liability for breach of the duty of due care is generally
imposed only when the director of officer behaves “recklessly” or with gross negligence.
2. Objective Standard: The standard of care is an objective one – the director is held to the
conduct what would be exercised by a reasonable person in the director’s position. (14A:6-14(1))
a) Special Skills: If the director has special skills (e.g. lawyer, accountant, real estate
professional), those skill are imputed to the reasonable person when measuring that director’s
conduct.
3. Reliance on Experts and Committees: Directors are generally entitled to rely on experts, on
reports prepared by insiders, and on action taken by a committee of the board. Any such reliance is
only allowed if it is “reasonable” under the circumstances. (14A:6-14(2))
4. Passive Negligence: A director will not be liable merely for failing to detect wrongdoing by
officers or employees. However, if the director is on notice of facts suggesting wrongdoing, he cannot
close his eyes to these facts. Also, in large corporations, it may constitute a violation of due care for
the directors not to put into place monitoring mechanisms to detect wrongdoing (e.g. audit
committee, stringent internal accounting controls).
5. New Jersey Limitations: New Jersey law allows for the articles to contain a provision disclaiming
personal liability for a directors breach of duty of care. A director may not be relieved of liability for:
breach of the duty of loyalty, failing to act in good faith / violating the law, and self dealing. (14A:27(3))
14
6. New Jersey Indemnification: New Jersey allows corporations to indemnify directors and officers
against claims of breach of duty of care. (14A:3-5(2))
B. Business Judgment Rule (BJR)
1. Definition: The Business Judgment Rule is a rebuttable presumption that corporate business
decisions are made by disinterested and independent directors, action on an informed basis, and in
the good faith and rational belief that the decisions are in the best interests of the corporation and its
shareholders.
a) Unless that presumption can be rebutted successfully, a court will dismiss any law suite
challenging a board’s business decision.
b) In effect, when the court applies the BJR, it adopts a “hands off” standard of judicial
review and presumes that the business decision being challenged was the product of sound
business judgment.
2. Exemptions: Even where the requirements of the BJR are met, there are two situations where
the court may find the rule inapplicable:
a) Illegal: if the act taken or approved by an officer or director is a violation of a criminal
statute, the defendant will lose the benefit of the BJR.
b) Pursuit of “Social” Goals: Some courts may hold the BJR inapplicable if the director is
pursuing his own social or political goals – unrelated to the corporation’s welfare). Other
court’s do not agree.
3. Policy Behind BJR
a) It does not benefit society to have state corporate law allow courts to re-evaluate all
business decisions, applying their own concepts of sound business judgment, and hold
directors personally liable for any and all bad decisions. This would result in:
(1) Many talented individuals, fearing personal liability, might refuse to serve on
corporate boards
(2) Those who do serve on corporate boards might become too timid and risk adverse
to be effective managers.
b) At the same time, however, we do not want to provide directors with absolute protection
against liability. This may well lead shareholders to suffer from directors who act recklessly,
lazily, or purely out of self interest.
c) The BJR attempts to strike a balance between too much accountability for corporate
boards and too little.
4. Rebutting the BJR: In order to rebut the BJR presumption, one must prove at least one of the
following:
a) There was no “business decision”
(1) A Business Decision requires that there must have been a conscious exercise of
judgment in making a decision; and
(2) The decision involve the corporation’s lawful business.
(a) The BJR does not protect decisions that involve fraud, illegality or ultra
vires acts.
b) The directors acted in bad faith, without the honest belief that their action was in the
best interests of the corporation and its shareholders
c)
The directors acted without due care and/or without adequate information
(1) Directors are required to make informed business decisions. Directors must have
informed themselves of all reasonably available, material information about a
proposed business decision before making that decision. This does not, however,
compel directors to personally investigate every possible source or scrap of
information. Directors may rely on the corporation’s records and financial statements,
as well as the reports, opinions and statements of the corporation’s executives and
other employees as long as such reliance was reasonable. (14A:6-14(2))
15
d) The directors were not disinterested and independent
(1) A director is considered interested in a transaction if she will receive from it a
benefit not shared equally by the shareholders of the corporation and is not motivated
solely by the desire to advance the best interests of the corporation and its
shareholders.
(a) Director’s interest must me material – i.e. substantial rather than
incidental.
(2) The directors abused their discretion
e) Conclusory allegations will not meet the standard of rebuttal. Plaintiff must be prepared
to make specific factual allegations detailing the nature of the challenge to the board’s action if
he hopes to avoid dismissal of the claim.
C. Duty of Loyalty
1. Definition: The officers and directors owe a duty of loyalty to the corporation which involves
placing the interests of the corporation above their own personal interests. A self dealing transaction is
one which meets the following three conditions:
a) A “key player” (e.g. officer director, or controlling shareholder) and the corporation are on
opposite sides of a transaction.
b) The “key player” has helped influence the corporation’s decision to enter the transaction
c) The “key player’s” personal financial interests are at least potentially in conflict with the
financial interests of the corporation.
2. Conflict Of Interest - New Jersey: A contract involving a conflict of interest will be valid as
long as at least one of the following is true:
a) The transaction is found to be fair and reasonable as to the corporation at the time it
was authorized (14A:6-8(1)(a))
b) The conflict of interest is disclosed or known to the board / committee and the
board / committee approves of the transaction by either unanimous written consent (providing
at least one consenting director is disinterested), or by an affirmative vote by the majority of
the disinterested directors (even if though disinterred may be less than a quorum) (14A:68(1)(b))
c) Conflict of interest is known or disclosed to shareholders and they authorize, approve
or ratify the transaction. (14A:6-8(1)(c))
3. What Must Be Disclosed: Two kinds of information must be disclosed to the board before it
approves the transaction:
a) The material facts about the conflict
b) The material facts about the nature of the transaction.
4.
Who is “Disinterested”: A director will be interested if either:
a) He or an immediate member of his family has a financial interest in the transaction
b) He or a family member has a relationship with the other party to the transaction that
would reasonably be expected to affect his judgment about the transaction.
5. Quorum: A quorum for the vote by disinterested directors merely has to consist of a majority of
the disinterred directors, not a majority of the total directors. (14A:6-8(1)(b)).
a) Interested directors can be counted towards a quorum, but cannot vote.
6.
Fairness: Fairness is judged at the time of the transaction, not by the results.
7. Immunization of Unfairness: The fact that a majority of the disinterested directors, acting
under full disclosure, have approved or ratified a transaction does not necessarily immunize it from
attack if the unfairness is very great. The existence of such approva/ratification shifts the burden of
proof to the person attacking the transaction, and the transaction will only be struck down if the
unfairness is so great as to constitute fraud or waste.
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8. Remedies for Violation: If there has been a violation of rule against self-dealing, there are two
possible remedies:
a) Rescission: Normally, the court will rescind the transaction, where this is possible.
b) Damages: If because of the passage of time or complexity of the transaction it cannot be
rescinded the court will award restitutionary damages. That is, the “key player” will have to
pay back to the corporation any benefit he received beyond what was fair.
D. Executive Compensation
1. Business Judgment Rule: If an officer or director influences a corporation’s decision about his
own compensation, this is technically a self-dealing transaction. The courts, however, have given such
decisions the protection of the BJR – the director’s decision will be sustained so long as it was rational,
informed, and made in good faith (despite not meeting the element of being disinterested).
2. Excessive Compensation: Even if the compensation scheme has been approved by a majority of
the disinterred directors, or ratified by the shareholders, the court may still overturn it if the level of
compensation is excessive or unreasonable. The compensation level must be reasonably related to the
value of the services performed by the executive (unless provided otherwise in the articles or bylaws).
a) No Consideration: If there is payment without consideration (e.g. a bonus on work
already performed, a gift) the court may find such payments wasteful. This is a fact intensive
determination. Intangibles such as corporate good will or investment in future relationships
should be considered.
b) Not Only Paychecks: Other forms of payment besides paychecks may be considered as
compensation (i.e. stock options, bonuses, gifts).
c) Few Cases: Courts very rarely strike down a compensation plan as excessive. Only
exception may be where a plan makes use of a formula which in not amended even though
conditions change.
E. The Corporate Opportunity Doctrine
1. Corporate Opportunities: The duty of loyalty of directors and officers to the corporation prevent
them form taking opportunities for themselves that should belong to the corporation.
a) Use of Corporate Property: A director may not use corporate property or assets to
develop his own business or for other personal uses.
b) Corporate Expectancies: A director or officer may not assume for himself properties or
interests in which the corporations is “interested,” or in which the corporation can be said to
have a tangible “expectancy,” or ones that are important to the corporation’s business or
purpose.
2. Tests to Determine Corporate Opportunity: The following 4 tests are often used to determine
whether a corporate opportunity existed.
a) Interest or Expectancy Test: (Oldest) The corporation has an interest in an opportunity
if it already has come contract right regarding the opportunity. A corporation has an
expectancy concerning an opportunity if its existing business arrangements have led it to
reasonably anticipate being able to take advantage of that opportunity.
b) Line of Business Test: (More Popular): A corporate opportunity exists if it is one which is
closely related to the corporations existing or prospective business.
c) Fairness Test: The court measures the overall unfairness, on the plaintiff’s facts, that
would result if the insider took the opportunity for himself.
d) Combination: 2 step test under which courts combine the “line of business” test and the
“fairness” tests. Corporate opportunity is found only if both tests are satisfied.
3. Defenses to Charges of Usurping Corporate Opportunity
a) Individual Capacity: Defendants may claim that the opportunity was presented to them
in their individual capacities, and not as fiduciaries of the corporation.
b) Corporation Unable to Take Advantage: The law is that an officer or director may take
advantage of a corporate opportunity when it is disclosed to the corporation first, and the
corporation is unable to take advantage of it.
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c) Corporation Refuses Opportunity: If the corporation, by independent directors or
shareholders, turns down or abandons an opportunity, fiduciaries may take advantage of the
opportunity.
d) No Conflict: Insider’s seizure of an opportunity does not result in a conflict between the
insider’s fiduciary duties to the corporation and the self interest of the director as actualized by
the exploitation of the opportunity.
4.
Breach of Duty By Board
a) If the board rejects a profitable enterprise, they may be subject to a shareholder claim of
breach of duty of care. (Derivate suit, board is protected by BJR).
5.
Shareholders Duty
a) REMEMBER: Shareholders (who are not directors) have not fiduciary duty to the
corporation!
XIV.
CLOSE CORPORATIONS – GENERALLY
A. What Is a Close Corporation
1.
A close corporation is one with the following traits:
a) A small number of stockholders
b) The lack of any ready market for the corporation’s stock; and
c) Substantial participation by the majority stockholder(s) in the management, direction and
operation of the corporation.
B. Significance of Close Corporation Status
1. Close corporations present special problems relating to control. The various devices examined
here are mainly ways of insuring that a minority stockholder will not be taken advantage of by the
majority holder(s).
C. Fiduciary Duty of Shareholders
1. Some states holder that there is a fiduciary duty owed to minority shareholders by the majority of
good faith and fair dealing. (MA and other states. Not in DE)
2. In some states, if a shareholder has a controlling interest, but NOT a majority (e.g. veto power via
a super majority provision), a fiduciary duty exists as if he were a majority shareholder. (MA and
others. Not DE).
XV. SHAREHOLDER VOTING AGREEMENTS, VOTING TRUSTS AND CLASSIFIED STOCK
A. Voting Agreements
1. Generally: A shareholder voting agreement is an agreement in which two or more shareholders
agree to vote together as a unit on certain or all matters. Some agreements expressly provide how
votes will be case. Other agreements merely commit the parties to vote together (without specifying
how the vote is to go, so that the parties must reach future agreement).
2. Validity: Voting agreements between 2 or more people are valid in NJ if in writing and signed by
the parties thereto. (14A:5-21(1))
3.
Enforcement: There are two ways a voting agreement may be enforced:
a) Proxy: The agreement may require each signatory to give a third person an proxy to vote
the signer’s share in accordance with the agreement. This proxy will be valid for 11 months
unless otherwise provided. The proxy will revocable at will unless otherwise stated. (14A:519(1))
b) Specific Performance: Most courts today will grant specific performance of the terms of
the voting agreement.
B. Voting Trust
1. Generally: In a voting trust, the shareholders who are part of the arrangement convey legal title
to their share to one or more voting trustees, under the terms of the voting trust agreement. The
18
shareholders become “beneficial owners” – they receive a “voting trust certificate” representing their
beneficial interest, and get dividends and sale proceeds They no longer, however, have voting power.
(14A:5-20)
2. Validity & Requirements: NJ will enforce voting trusts if they conform with the following
statutory requirements:
a) Maximum Term: Trust is not to exceed 21 years (14A:5-20(1); 14A:5-20(5))
b) Disclosure: Must file an executed counterpart of the agreement at the registered office of
the corporation (14A:5-20)(1)
c)
Writing: Trust must be in writing (14A:5-20(1))
d) Transfer of Shares: Must be a formal transfer of shares from the beneficiaries to the
trustees and new certificates will be issued to the trustee stating they are issued under such
an agreement. This change in ownership will also be noted in the records of the corporation.
(14A:5-20(1)).
3. Strict Compliance: These requirements must be strictly adhered to. If not, the court is likely to
hold the entire agreement unenforceable.
C. Classified Stock and Weighted Voting
1. Generally: Shareholders may reallocate their voting power (and give minority holders a bigger
vote) by using classified stock. The corporation sets up two or more classes of stock, and gives each
class different voting rights or financial rights.
2.
XVI.
Validity: NJ allows for the issuance of classes of stock and special voting rights under 14A:7-1(2)
AGREEMENTS RESTRICTING THE BOARD’S DISCRETION
A. Problem Generally
1. If the shareholders agree to restrict their discretion as directors, there is a risk that the agreement
will violate the principle that the business shall be managed by the board of directors. If a court finds
that the board’s discretion has been unduly fettered, it may refuse to enforce the agreement.
B. Present View
1. Most courts will probably uphold even a shareholder agreement that substantially curtails the
board’s discretion, so long as the agreement:
a) Does not injure any minority shareholder
b) Does not injure creditors or the public; and
c)
Does not violate any express statutory provision.
C. New Jersey View (14A:5-21(2))
1. A voting agreement which restricts the board in the management of the business will be held as
valid, even if it is otherwise prohibited by law, if:
a) All the incorporators have authorized the provision in the articles; OR
b) The holders of record of ALL outstanding shares (whether having voting power or not)
have authorized such a provision in an amendment to the articles.
2.
A voting agreement restricting the board’s management powers will not be found valid if:
a) Subsequent to the adoption of the provision, shares are transferred to a person who takes
delivery without notice of the provision (unless person consents in writing) (14A:5-21(3)(a));
OR
b) The shares are traded publicly. (14A:5-21(3)(b))
XVII.
SUPER-MAJORITY VOTING AND QUORUM REQUIREMENTS
A. New Jersey View: NJ allows the shareholders to agree that a super-majority will be required for a vote
or a quorum. In general, such super-majority quorum and voting requirements are upheld even if they require
unanimity. (14A:5-12)
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1. Changing a Requirement: If the charter is drafted to impose a super-majority voting or quorum
requirement, some status allow the super-majority provision to be removed or changed only by the
same super-majority percentage. (14A:5-12(2))
XVIII. SHARE TRANSFER RESTRICTIONS
A. Why Used
1. The shareholders of a close corporation will often agree to limit the transferability of share in the
corporation. This lets shareholders veto the admission of new “colleagues” and helps preserve the
existing balance of control.
B. Enforcement: Share transfer restrictions will generally be enforced, so long as they are
reasonable.
1. How Imposed: Share restrictions may be imposed either by a formal agreement among the
shareholders or, in some instances, by an amendment to the articles of incorporation or the bylaws.
C. Various Techniques: There are 5 principal techniques for restricting share transfers:
1. First Refusal: Under A right of first refusal, a shareholder may not sell his shares to an outsider
without first offering the corporation or the other shareholders (or both) a right to buy those shares at
the same price and terms as those at which the outsider is proposing to buy.
2. First Option: The ”first option” is similar to the right of first refusal, except that the price is
determined by the agreement creating the option.
3. Consent: Stock transfers may be made subject to the consent of the board of directors or the
other shareholders.
4. Stock Buy-Back: A buy-back right is given to the corporation to enable it to buy back a holder’s
shares on the happening of certain events, whether the holder wants to sell or not. The corporation is
not obligated to exercise a buy-back right.
5. Buy-Sell Agreement: A buy-sell agreement is similar to a buy-back right, except that the
corporation is obligated to go through with the purchase upon the happening of the specified event.
D. Notice and Consent:
1.
Not everyone is necessarily bound by a share transfer restriction:
a) Signer: Obviously if the shareholder signs the agreement he will be bound.
b) Subsequent Purchaser Without Notice: A person who purchases shares without actual
knowledge of pre-existing restrictions will generally not be bound by the restriction. However,
if the restriction is conspicuously noted on the share certificates, he will be bound.
c) Non-Consenting Minority Holder: Courts are split as to whether a person who is
already a shareholder at the time the restrictions are imposed (and does not consent) is
bound. MBCA provides that such a holder will not be bound.
E. Valuation:
1. Most transfer restrictions require some valuation to be placed on the stock at some point. There
are four common techniques:
a) Book Value: The value may be based upon the book value. This is basically the
corporation’s assets minus its liabilities. (Sometimes adjustments will be made to the
corporation’s historical balance sheet figures to arrive at the book value used for valuation0.
b) Capitalized Earnings Method: The parties use a formula that attempts to estimate the
future earnings of the business, and they then discount these earnings to present value.
c) Mutual Agreement Method: The parties agree upon an initial fixed valuation and also
agree that from time to time they will mutually agree upon an adjusted number to reflect
changes in the market value.
d) Appraisal: The parties agree in advance on a procedure by which a neutral third-party
appraiser will be selected; the appraiser then determines the value.
F.
Requirement of “Reasonableness”
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1.
Transfer restrictions will only be upheld if they are “reasonable.”
a) Outright Prohibition and Consent Requirements: Courts are especially likely to strike
down an outright prohibition on the transfer of shares to third parties. Similarly, a provision
that shares may not be sold to outsiders without the consent of the other shareholders is likely
to be found unreasonable, if the others are permitted to withhold their consent arbitrarily.
b) Options, First Refusals and Buy-Sell Agreements: These types of restrictions are
likely to be found reasonable. In general, if the mechanism chosen by the parties is reasonable
at the time the method was agreed upon, it will probably be found reasonable (and upheld)
even though it turns out to produce a price that is much higher or lower than the market price
at the time of sale.
XIX.
RESOLUTION OF DISPUTES, INCLUDING DISSOLUTION (14A:12-7)
A. Dissension and Deadlock
1. “Dissension” refers to squabbles or disagreements among them. “Deadlock” refers to a situation
where the corporation is paralyzed and prevented from acting.
B. Freeze Out & Oppression
1. A shareholder may claim they are being oppressed or frozen out and attempt to force fellow
shareholders to buy him out. In order to claim oppression, a shareholder must show:
a) The board’s action(s) defeats his objectively viewed expectations at the time he entered
into the corporation
b) Defeats his expectations for investment.
C. Dissolution
1. The major judicial remedy for dissension and deadlock is a court order that the corporation be
involuntarily dissolved. Dissolution means that the corporation ceases to exist as a legal entity; the
assets are sold off, the debts are paid, and any surplus is distributed to the shareholders. (14A:127(1))
2. Dissolution Not Mandatory: No state gives a shareholder an automatic right to a judicially
ordered dissolution. NJ looks towards the best interests of the shareholders.(14A:12-7(9))
3. Remedy for Oppression: Often dissolution is used as a remedy to oppression of minority
shareholders. (14A:12-7(1)(a))
4. Buy-out in Lieu of Dissolution: The party opposing dissolution may have the right to buy-out
the shares of the party seeking dissolution at the judicially-supervised fair price. (14A:12-7(8))
D. Alternatives to Dissolution:
1.
There are a number of alternatives to dissolution, including:
a) Buy Out
b) Arbitration
c)
Court appointment of provisional director (to break a deadlock) (14A:12-7(3))
d) Court appointment of a custodian (who will run the business) (14A:12-7(4))
e) Appointment of a receiver (who will liquidate the business).
f)
A judicially supervised buy-out in lieu of dissolution.
2. Award of Damages: If the court does find that any party to transaction did not act in good faith,
the court may award reasonable expenses to the injured party. (14A:12-7(10)).
3. Noncompliance: If the corporation does not comply with a court ordered alternative, the court
may then order dissolution of the corporation.
XX. SHAREHOLDER DERIVATIVE SUITS
A. What is a Derivative Suite:
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1. When a person who owes the corporation a fiduciary duty breaches the duty, the main remedy is
the shareholder’s derivative suit. In a derivative suit, an individual shareholder (typically an outsider)
brings suit in the name of the corporation, against the individual wrongdoer.
a) Against Insider: A derivative suit may in theory be brought against some outside third
party who has wronged the corporation, but is usually brought against an insider, such as a
director, officer, or major shareholder.
B. Distinguish Derivative for Direct Suit
1. A derivative suite is one which is brought on behalf of the corporation and any recover will go to
the corporation. A direct suit is brought on behalf of the individual shareholder and that shareholder
usually retains the recovery.
a) Typical Cause of Action for a Derivative Suit:
(1) Suits brought against board member for failing to use due care
(2) Suits against an officer for self dealing.
(3) Suits to recover excessive compensation paid to an officer
(4) Suits to reacquire a corporate opportunity usurped by and officer
b) Typical Cause of Action for a Direct Suit:
(1) An action to enforce the holder’s voting rights
(2) An action to compel the payment of dividends
(3) An action to prevent management from improperly entrenching itself (e.g. to
enjoin the enactment of a poison pill as an anti-takeover device)
(4) A suit to prevent oppression of minority shareholders
(5) A suite to compel inspection of the company’s books and records.
2.
Benefits of Direct Suit: If the suit is direct, P gets the following benefits:
a) Much simpler procedural requirements
b) Does not have to make a demand on the board, or face having the action terminated early
b/c the corporation does not want to pursue it.
c)
He can probably keep all of the recover.
C. Requirements of a Derivative Suit
1.
Summary: Three are three main requirements that P must generally meet for a derivative suit:
a) He must have been a shareholder at the time the acts complained of occurred (the
“contemporaneous ownership rule”)
b) He must still be a shareholder at the time of the suit
c) He must make a demand (unless excused) upon the board, requesting that the board
attempt to obtain redress for the corporation.
d) Also, in NJ, a holder of less than 5% of the outstanding shares may be required to give
security for reasonable expenses. (14A:3-6(3))
2. Contemporaneous Ownership Rule: P must have owned his shares at the time of the
transaction of which he complains.
a) Continuing Wrong Exception: P can sue to challenge a wrong that began before he
bought his shares, but that continued after the purchase
b) Who is a Shareholder: P must have been a shareholder at the time of the wrong. It is
enough if P held preferred stock, or will be the beneficial owner, even if he is not the owner of
record. A bond holder or other ordinary creditor may not bring a derivative suit.
3. Continuing Ownership: P must continue to owner the share not only until the time of the suit,
but until the moment of judgment.
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4. Demand on Board: P must make a written demand on the board of directors before commencing
the derivative suit. The demand asks the board to bring a suit or take other corrective action. Only if
the board refuses to act may P then commence suit.
a) Often the demand is excused – see below.
5. NJ Bond Needed: NJ requires that when bringing suit, the holder of less than 5% of the
outstanding shares of any class to give security for reasonable expenses UNLESS the percentage held
has a market value of over $25,000. (14A:3-6(3))
D. Demand on Board / Early Termination Based on Board or Committee Recommendation
1. Demand Excused: Demand on the board is excused where it would be futile. In general, a
demand will be deemed to be futile if the board is accused of having participated in the wrongdoing.
2. Demand Required and Refused: If demand is required, and the board rejects the demand, the
result depends in part on who the defendant is:
a) Unaffiliated 3rd Party: If the suite is against a third party who is not a corporate insider,
P will almost never be permitted to continue his suit after the board has rejected it.
b) Suit Against Insider: Where (as is usually the case) the suit is against a corporate
insider, P has a better chance of having the board’s refusal to pursue the suit be overridden by
a court if P can show that either:
(1) The board somehow participated in the alleged wrong; or
(2) The directors who voted to reject the suit were dominated or controlled by the
primary wrongdoers.
3. New Jersey – Modified BJR: In New Jersey, the burden is placed on the company (whether
demand refused or futile) to show the directors were independent, acted in good faith, and that the
decision not to pursue the suit was reasonable.
4. Independent Committee: Today, the corporation usually responds to Ps demand by appointing
an independent committee of directors to study whether the suit should be pursued. Often, but not
always, the court will give this committee recommendation the protection of the BJR and will therefore
terminate the action before trial.
a) NJ and DE Treatment: In NJ and DE, the court will examine:
(1) The independence and good faith of the committee and the basis for its
conclusions (burden on the corporation to prove that it was independent, acted in
good faith, and conducted a reasonable investigation).
(2) Court then applies its own business judgment to whether the motion should be
dismissed.
(3) Zapata v. Maldonado p. 724
E. Settlement of Derivative Suits
1. Judicial Approval: Most states require that any settlement of a derivative suit be approved by
the court. The court must be convinced that the settlement is in the best interest of the corporation
and its shareholders.
a) Factors: When the court decides whether to approve the settlement, the most important
factor is usually the relation between the size of the net financial benefit to the corporation
under the settlement and the probable net benefit if the case were tried.
2. Notice: In federal courts and in many states, shareholders must be given notice of any proposed
settlement of a derivative action, as well as the opportunity to intervene in the action to oppose the
settlement.
3. Corporate Recovery: All payments made in connection with the derivative action must be
received by the corporation, no by the plaintiff.
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A
Accumulated Earnings, 6
Apparent Authority, 13
Appraisal, 21
Article of Incorporation, 5
B
Board Of directors, 11
Acts, 12
Committees, 13
Discretion, Agreements Restricting, 19
Duration of Term, 12
Election, 11
Meetings, 12
Number of Directors, 12
Quorum, 12
Removal, 12
Resignation, 12
Vacancies, 12
Book Value, 21
Bord of Directors
Agreements Restriction Board's Discretion, 19
Business Judgment Rule (BJR), 15
Buy-out, 21
Buy-Sell Agreement, 20
C
Capital Surplus, 6
Capitalized Earnings Method, 21
CHARACTERISTICS OF A CORPORATION, 4
Classified Stock, 19
Close Corporation, 18
Common Stock, 5
Conflict Of Interest, 16
Contemporaneous Ownership Rule, 23
Continuing Wrong Exception, 23
Convertible Preferred, 6
Corporate Expectancies, 17
Corporate Opportunity Doctrine, 17
Corporation By Estoppel, 9
Cranson v. IBM Corp, 9
Cumulative Preferred Stock, 6
Cumulative Voting, 12
D
De Facto Corporation, 8
De Jure Corporation, 8
Deadlock, 21
Demand Excused, 23
Demand on Board, 23
Demand Required and Refused, 23
derivative suits, 22
Requirements of A Derivative Suit, 22
Settlement, 24
Direct Suit, 22
Directors, 10
Fiduciary Duties, 14
Powers of Directors, 11
Dissension, 21
Dissolution, 21
Alternatives to Dissolution, 22
Dividends, 6
Dominance of subsidiary, 10
Duty of Care, 14
Duty of Loyalty, 16
E
Earned Surplus, 6
Executive Compensation, 17
Express Actual Authority, 13
F
First Option, 20
First Refusal, 20
Freeze Out, 21
H
Holdover Director, 12
I
Implied Actual Authority, 13
J
Joint Venture
Partnership Compared, 1
M
Meinhard v. Salmon, 3
Mutual Agreement Method, 21
N
National Biscuit Company v. Stroud, 3
No Par Stock, 6
O
Officers, 11, 13
Authority, 13
Definition, 13
Fiduciary Duties, 14
Hire and Fire, 13
Powers of Officers, 11
Oppression, 21
P
Par Stock, 6
Par Value, 6
Partnership
Admissions, 3
Apparent Authority, 3
Authority & Agency, 3
Basic Nature of a Partnership, 1
Capacity to Become a Partner, 1
Consent of Other Partners, 1
Deadlock, 3
Dissolution, 4
Durantion, 1
Duty of Care, 2
Duty of Disclosure, 2
Duty of Loyalty, 2
Effects of the Partnership Relationship, 2
Equal Rights, 3
Fiduciary Obligations of Partners, 2
Formalities, 1
Good Faith, 2
Intent of the Parties, 1
Lend Money, 2
Lenders, 1
Liability to 3rd Parties, 3
Limits on Authority, 3
Majority Rule, 3
Managment, 3
Partnership Agreement, 2
Partnership by Contract, 1
Partnership by Estoppel, 2
Partnership Property, 3
Profits and Losses, 2
Self Interest, 2
Tort Liability, 3
Transfer of Interest, 3
Piercing the corporate veil, 9
Preemptive Rights, 7
Preferred Stock, 5
Promoters, 7
Defined, 7
Fiduciary Responsibilities, 7
Liability, 7
Liability – Flow Chart, 8
Purchasable Stock, 6
Q
Quorum requirements, 20
R
Ratification, 14
Redeemable Stock, 6
Resolution of disputes, including dissolution, 21
Retained Earnings, 6
S
Share transfer restrictions, 20
Shareholder Action, 14
Shareholders, 10
Annual Meetings, 14
Breaking Quorum, 14
Meetings, 14
Powers of Shareholders, 11
Quorum, 14
Special Meetings, 14
Shares, 5
Stated Capital, 6
Stock Buy-Back, 20
Straight Voting, 12
Super-majority voting, 20
U
Ultra Vires, 7
Un-appropriated Profit, 6
V
Valuation, 21
Voting Agreements, 18
Voting Trust, 19
W
Watered Stock, 6
Weighted Voting, 19