LA 245 Week 9 Notes
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This 11 page Class Notes was uploaded by Frankie Fucci on Thursday March 17, 2016. The Class Notes belongs to LA 245 at Boston University taught by David Randall in Spring 2016. Since its upload, it has received 18 views. For similar materials see Introduction to Law in Law at Boston University.
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Date Created: 03/17/16
Corporations Promoter's Liability Promoter: someone who organizes a corporation o It's his idea, he raises the capital, hires lawyers, calls the shots o Promoter is personally liable on any contract he signs before the corporation is formed After formation, corporation can adopt (agree to be bound by the terms of the contract) the contract, in which case both it and the promoter are liable Promoter can only be released from liability if the other party agrees to a novation (new contract with corporation and third party alone) Third party must agree to this Incorporation Process No federal corporation code, company can only incorporate under state, not federal law o Can still do business in any state American Bar Association drafted Model Business Corporation Act (The Model Act) - a guide to encourage similarity among state corporation statutes o Most have adopted this, except Delaware, who despite its size has a large influence on corporate law More than half all public companies have incorporated there, including 60% of Fortune 500 companies Where to Incorporate? o Domestic corporation: what a company is called in the state where it is incorporated o Foreign corporation: corporation formed in another state o Companies usually incorporate in the state where they do the most business or in Delaware Usually must pay filing fees and franchise taxes in their state of incorporation, plus in any state in which they do business Avoid double set of fees: incorporate in state where will do most business, instead of Delaware If going to do business in many states, beneficial to incorporate in Delaware as it has some benefits: Laws that favor management Most states require unanimous agreement by shareholders to hold a vote in writing rather than in a meeting, Delaware only requires a majority vote Delaware legislation tries to keep up-to-date by changing its code to reflect new developments in corporate law Efficient court system Chancery Court: special court that hears only business cases and has judges who are experts in corporate laws Established body of precedent So many businesses incorporate there, so its court hear a vast number of cases --> lawyers feel they can more easily predict the outcome of a case in Delaware The Charter o Defines the corporation o States use different terms to refer to a charter: "articles of incorporation", "articles of organization", "certificate" rather than articles o Name Model Act imposes two requirements All corporations must use one of the following words in their name: "corporation", "incorporated", "company", or "limited" New corporate name must be different from that of any corporation, LLC or limited partnership that already exists in the state Delaware Also accepts words "association" or "institution" Also follows Model Act's second requirement o Address and Registered Agent Company must have official address in the state in which it is incorporated so Secretary of State knows where to contact it and so anyone who wants to sue the corporation can serve the complaint in-state Most companies incorporated in Delaware don't have an office there, they fire a registers agent to serve as their official presence in the state o Incorporator: signs the charter and delivers it to the Secretary of State Not required to buy stock, nor do they necessarily have any future relationship with the company Usually lawyer takes on this role, if no lawyer, the promoter is usually also the incorporator o Purpose: corporation is required to give its purpose for existence Most companies make these very broad - "The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of (state)" o Stock - charter must provide 3 items of info about company stock Par value - meant to be close to market value; company could not issue stock at a price less than par (so couldn't sell to insiders at a sweetheart price) Now, par value doesn't relate to market value - it's usually some nominal figure such as one cent or one dollar per share Can also issue stock with no par value Number of shares - can authorize as many shares as incorporators choose, but the more shares, the higher the filing fee After incorporation, company can add authorized shares by amending the charter and paying the additional fee Authorized and unissued: stock that has been authorized but not yet sold Authorized and issued: stock that has been sold Treasury stock: stock that company sold but later bought back Classes and Series - different shareholders often make different contributions to a company Corporate structure can be infinitely flexible in defining the rights of these various shareholders Classes: categories that divide stock Series: subcategories that future divide classes All stocks in a series have the same rights and all series in a class are fundamentally the same, except for minor distinctions Defining the rights of a class/series can contain virtually any combination of the following: Dividend rights - whether shareholder is entitled to dividends and what amount Voting rights - shareholders usually entitled to elect directors and vote on charter amendments, among other issues Different series can have different voting rights Liquidation rights - the order in which classes of stockholders will be paid upon dissolution of the company Some stocks come "prepackaged" (Model Act doesn't use these terms anymore) Preferred stock: owners of preferred stick have preference on dividends and also, typically, liquidation If holders of cumulative preferred stick miss their dividend one year, common shareholders cannot receive a dividend until the cumulative preferred stakeholders have been paid all they are owed, no matter how long it takes Holders of non-cumulative preferred stock lose an annual dividend for good if the company cannot afford it in the year it's due Common stock - last in line for any company payouts, including dividends and liquidation Participating preferred stock - upon liquidation, these shareholders are paid first, receiving whatever they paid plus accrued dividends Then, treated as if they had converted preferred shares into common stocks, so they also share the rest of the proceeds with common shareholders This type is often chosen by venture capitalists - professional investors in the business of financing companies) After Incorporation Directors and Officers o Once organized, incorporators elect firs set of directors Thereafter, shareholders elect directors o Model Act - corporation is required to have at least one director unless: All shareholders sign an agreement that eliminated the board, or Corporation has 50 of fewer shareholders o To elect directors, shareholders hold a meeting, or in the more typical case for a small company, elect directors by written consent o Once directors are chosen, they must elect the officers of the corporation Can have a consent form is they want, Model Act is flexible Requires corporation to have whatever officers are described in the bylaws Same person have hold more than one office o Minute book: official record of a corporation Written consent and any records of actual meetings are kept here Bylaws: document that specifies the organizational rules of a corporation or other organization, such as the date of the annual meeting, the required number of directors, give titles to officers and establish the fiscal (tax) year o Defines the quorum: percentage of stock that must be represented for a meeting to count Issuing Debt o Equity (i.e. stock) - described in the charter, debt is not o Authorizing debt often one of the first steps a new company takes o Several types of debt Bonds: long-term debt secured by company assets; if unable to pay the best, creditors have a right to specific assets Debentures: long-term unsecured debt; if company cannot meet its obligations, debenture holders are paid after bondholders but before stockholders Notes: short-term debt, typically payable w/in 5 years; may be secured/unsecured Death of a Corporation Death can be voluntary (shareholders elect to terminate) or forced (by court order) o Sometimes court takes a step that's much more damaging to shareholders - take away their limited liability Piercing the Corporate Veil o One of the major purposes of a corporation is to protect its owners from personal liability for the debts of the organization o Pierce the corporate veil: court holds shareholders personally liable for the debts of the corporation; usually done in four circumstances: Failure to observe formalities - if organization doesn't act like a corporation, it won't be treated as one Commingling of assets - shareholders mix their assets with those of the corporation Can cause confusion for creditors to determine which assets belong to whom --> generally resolved in favor of creditors - all assets are deemed to belong to corporation Inadequate capitalization - if founders of corporation don't raise enough capital to give business fighting chance of paying its debts, courts may require shareholders to pay corporate obligations Therefore, if corporation doesn't have sufficient capital, it needs to buy insurance, particularly to protect against tort liability Fraud - if fraud committed in the name of the corporation, victims can make a claim against the personal assets of the shareholders who profited from the fraud Brooks v. Becker Becker, sole shareholder, officer and director of Becker Interiors Becker and his partner LaPointe used about $300,000 of company funds to renovate their residence, pay their personal credit card bills and invest in another company in which Becker was president, also deposited funds into his account from selling a corporate car and company's tax refund check Becker Interiors supervised major renovation of a house in Virginia, hired Brooks as subcontractor on the project When company refused to pay him, he sued them, winning a judgement against the company of about $54,000, but turned out the company had no assets Brooks then sued Ronald Becker in attempt to hold him personally liable for the debts of the corporation Issue: Can Brooks pierce the corporate veil? Is Becker personally liable for the debts of the corp? Defendant ignored the separate existence of the corporate entity which imposes personal liability upon shareholders for debts of corporation Only warranted under extreme situations, this is not one Becker knowingly used the corporation as his personal piggy bank and his defense claims are not credible Court decides to enter judgement against Becker in the owed amount Termination - 3 step process: o Vote - directors recommend to shareholders that corporation be dissolved, majority of shareholders agree o Filing - corporation files "Articles of Dissolution" with Secretary of State o Winding Up - officers pay corporation's debts and distribute the remaining property to shareholders When completed, the corporation ceases to exit o Secretary of State may dissolve a corporation that violates state law Corporations Organizations Characteristics Three-part structure o Shareholders: own the corporations and elect directors o Board of directors: manage corporation's business for benefit of shareholders, and hire corporate officers o Corporate officers: run the corporation's business day-to-day Limited Liability: corporate shareholders have limited liability for business obligation o Doesn't protect you personally from your own wrongdoing Transferability: shareholders can sell corporate stock freely o EXCEPT in the case of a closely-held corporation, or other privately-held corporations that restrict this o **Reminder: private doesn’t mean small (ex: Cargill) Perpetual existence: corporations continue in existence until steps are taken the terminate them Federal Law - taxation of corporation income governed primarily by federal tax law C Corporation: pays income tax - it is not a pass-through entity o Default form of corporation S Corporation: benefits o limited liability but with the added benefit of pass-through entity o Limitations: cannot have more than 100 members What is promoter's liability? Dissolve liability of promoter => must create a novation - new contract where promoter is not involved o Three-way contract - the other party of the contract has to agree with this as well between corporation, promoter and third party Why must corporation's name include "Inc.", "Incorporated", "LTD", etc.? So you know what it is Ensures no confusion in legal matters Third parties when entering into contracts Stock Preferred: has preference on dividends and liquidation o Cumulative: if corporation doesn't pay dividend one year, then holders are entitled to receive all unpaid dividends in the next year in which the corporation pays dividends, before common shareholders receive any dividends o Non-cumulative: if corp doesn’t pay dividend one year, then holders lose their right to receive payment of it Common: last in line for corporate payouts, including dividends and liquidation payments o If it's last in line, then what are benefits of common stock ownership? No limit on what you can receive, once everyone else has been paid Voting stock, usually CONTINUE ON THURSDAY Corporations (continued) Role of Corporate Management One of most important challenges a growing business faces is attracting outside investors - people with money but without the desire to manage the enterprise o Shareholder elect directors to manage their interests so those interests are protected without getting involved Directors set policy and then appoint officers to implement corporate goals As mangers of the corporation, directors have important responsibilities o shareholders and to stakeholders: anyone who is affected by the activities of a corporation o The interests of these various groups often conflict Managers have a fiduciary duty to act in the best interest of the corporation's shareholders o Shareholders mainly concerned with maximizing their ROI/stock value o Many states have adopted statutes that permit directors take into account interests of stakeholders as well The Business Judgement Rule: courts allow managers great leeway in carrying out responsible of their fiduciary duty to act in best interest of stockholders Common law concept that has achieved national acceptant To be protected by this rule, managers must act in good faith: o Without conflict of interest (Duty of Loyalty) o With the care that an ordinarily prudent person would take in similar situation (Duty of Care), and o In a manner they reasonably believe to be in the best interests of the corporation (Duty of Care) Protects both the manager and his decisions o If manager comply with the business judgement rule, court will not hold them personally liable for any harm their decisions cause the company, not will the court rescind their decisions Accomplishes 3 goals: o Permits directors to do their job - if they were always afraid of being liable for every decisions, they would never make decisions, or at least risky ones o Keeps judges out of corporate management - without this rule, judges would be tempted, if not required, to second-guess managers' decisions o Encourages directors to serve - provides protection so they feel safe/secure Duty of Loyalty: prohibits managers from making a decision that benefits them at the expense of the corporation o Self-Dealing: manager makes a decision benefitting either himself or another company with which he has a relationship Does not apply under business judgement rule Self-dealing transaction only valid id: Disinterested members of the board of directors approve the transaction Disinterested directors are those who do not themselves benefit from the transaction Disinterested shareholders approve it Transaction was entirely fair to the corporation In determining fairness, courts will consider the impact of the transaction on corporation and whether the price was reasonable o Corporate Opportunity - prohibits managers from excluding their company from favorable deals Managers are in violation of corporate opportunity doctrine is they compete against the corporation without its consent Anderson v. Bellino Bellino and Anderson formed Lottery - restaurant, lounge and keno game Each owned 50% of the stock and both were officers and directors Over time, both were involved but Bellino spent more time, in part because of his personal relationship with Lottery's lounge manager During this time, Bellino didn't complain about Anderson's lack of involvement and Anderson never refused to do anything Bellino asked him Resentful of Anderson's lacking work ethic, Bellino convinced LaVista's city council to put the keno contract up for competitive bid Bellino incorporated LaVista Keno, Inc. to bid on the contract Bellino complained to Anderson and intended to resign and bid on city contract himself Anderson offered reconciliation, but Bellino refused Submitted a bid on behalf of Keno, but still officer/director/50% shareholder of Lottery Anderson bid as well, city awarded it to Keno Anderson/Lottery filed suit against Bellion/Keno, alleging they usurped corporate opportunity Lower court found for Anderson/Lottery Ordered Bellino to pay about $644,000 but provided Bellion could receive credit of $172000 against judgement, if Bellino transferred the stock of Keno and Lottery and persuaded the city to relicense the keno contract from Keno to Lottery Issues: Did Bellino usurp a corporate opportunity? Is he liable to Lottery? Bellino claims that if a corporate opportunity existed, it was limited to the opportunity to bid for the contract Claims he did nothing to impede Lottery from bidding for the Keno contract by submitting a competing bid --> therefore, did no usurp a corporate opportunity But, corporate opportunity wasn't the right to bid, bidding process was preliminary step The facts establish that the keno contract itself was a corporate opportunity Evidence shows that Bellino's successful bid on LaVista keno contract deprived Lottery of its only source of business Bellino, through Keno, shouldn't' have competed with Lottery for the contract Affirm district court order Duty of Care: requires officers/directors to act in the best interests of the corporation and to use the same care that an ordinarily prudent person would take in a similar action o Rational Business Purpose - directors/officers are liable for decisions that have no rational business purpose o Legality - courts generally unsympathetic to managers who engage in illegal behavior, even if goal is to help the company o Informed Decision - generally, courts will protect managers who make an informed decisions, even if the decision ultimately harms the company "informed decision" means carefully investigating the facts However, even if decision is uninformed, directors will not be held liable if decisions was entirely fair to the shareholders
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