J Money on 1Corporations 2011 Incorporation: A Corporation begins - when the articles of incorporation are filed with the state

(unless a delayed effective date is specified). [2.03] The Articles of Incorporation must set forth: (1) the NAME of the corporation, (2) The Number of Shares it is authorized to issue, (3) the Name and Address of its AGENT for service of process, and (4) the Name of Each Incorporator. [2.02] It may set forth other provisions. A corporation's Articles of Incorporation and its Bylaws together set forth its managing provisions.

If you pretend to act on behalf a Corporation and you know its not in existence You are Jointly and Severally Liable: - All persons purporting to act on behalf of a corporation are jointly and severally liable for actions taken on behalf of the corporation where they knew the corporation was not in existence. [2.04] o Even if 3rd party knows doesnt exist (3rd party must agree with promoter to only sue not him)(Stanly v. Boss) Stanly v. Boss- A promoter will be liable on a contract he entered into on behalf of a corporation yet-to-be-formed unless the other party agreed to look to some other person fund for payment. - 3 exceptions to this rule: (1) The contract is treated as an option which can be accepted by the corporation when it is formed, and the promoter agrees to form the corporation and give it the opportunity to pay (2) A novation with the corporation assuming the promoters liability and replacing him in the contract (3) The promoter remains liable even after formation but only as a surety - Novation- The substitution of one party for another in a contract with the approval of the remaining party and discharging the obligations of the released party. - Surety- A party who guarantees payment of the debt of another party to a creditor. - The law normally excuses an agent from liability for contracts he entered into in an agency capacity. The principals reputation and resources are the ones that induced the other party to enter into an agreement. When the principal is not yet in existence, the agents reputation and assets must be assumed to have induced the other party to enter the contract.

A defective filing still may not give rise to liability if there is no knowledge of the defect (there is a defacto corporation). While defacto corporations are not recognized under the MBCA, courts still sometimes recognize them. No Limited Liability before Certificate of Incorporation is given Unless Contracted otherwise

Perpetual Duration in unless the articles of incorporation provide otherwise, and may engage in virtually any form of legal activity. [3.02] Ultra vires acts - are acts the corporation lacks power to engage in, usually due to limitations in its Articles of Incorporation. [3.04] - Only the following can claim Ultra Vires: (Can be invoked by 3rd party Kings Hwy.) a. shareholders to enjoin the act; b. Corporation v. directors, officers, etc. (this would normally be a derivative action - $ goes back to not shareholders); and c. the attorney general. [3.04] Kings Highway Rule of Law- No act of a corporation and no transfer of property to or by a corporation otherwise lawful shall be held invalid by reason that the corporation was without capacity or power to do such act except in an action brought by a shareholder or in an action by or in the right of a corporation against an incumbent or former officer or director. Ulta vires notes- Ultra vires literally means beyond the powers. When a corporation does an act or enters into a contract beyond the scope of its charter, it is not necessarily illegal and it is not necessarily void. Rather it is voidable. However under the well known English case Ashbury Railway Carriage & Iron Co. v. Riche, the discussion surrounded the question of a contracts being void from the beginning because the object of the contract was beyond the powers of the corporation. The corporation was allowed to repudiate a contract on the ground of ultra vires after it had partially performed. However the doctrine of ulta vires is declining in importance and should not be applied to purposes clauses of articles of incorporation Charitable contributions - are generally permitted by corporations. [3.02] However, if charitable gifts are challenged by a stockholder, there probably has to be a valid corporate purpose for the gift and a reasonable limitation as to the amount given. [The Board of Directors may only approve actions that are in the best interest of the shareholders. Piercing the Corporate Veil: Shareholders are not normally liable for the debts and obligations of a corporation. [6.22] However at common law, the shareholders may be held liable where a court finds that the 2

corporation: a. is a mere instrumentality or alter ego of the shareholders; b. fails to follow corporate formalities; c. is grossly undercapitalized; d. maintains no corporate records; or e. is otherwise used to defraud creditors. Bartle v. Home Owners Co-op Rule of law- Where there has been no fraud, misrepresentation, or illegality, the doctrine of piercing the corporate veil will not be invoked to hold a corporation liable for the debts of a wholly owned subsidiary (Subsidiary def)- A company a majority of whose shares are owned by another corporation and which is subject to that corporations control. DeWitt Truck Brokers v. W. Ray Flemming Fruit Co. Rule of law- A court will pierce the corporate veil when recognition of the corporate form would extend the principle of incorporation beyond its legitimate purposes and would produce injustices or inequitable consequences. Baatz v. Arrow Bar Rule of law- In determining whether the corporate veil should be pierced, the court must regard the corporation as a separate legal entity in the absence of sufficient evidence to the contrary. Radaszewski v. Telecom Corp. Rule of Law- To pierce the corporate veil, one must show control amounting to complete domination, use of that control for an improper motive which breaches a duty owned, and injury proximately caused by that breach. United States v. Bestfoods Rule of Law- A corporate parent that actively participated in, and exercised control over, the operations of a polluting facility itself may, without more, be held directly liable in its own right as an operator of a facility. Stark v. Flemming Rule of Law- Where corporate formalities have been observed, the form cannot be disregarded unless authorized by statute Roccograndi v. Unemployment Comp. Rule of Law- The corporate form may be ignored where applicants for unemployment compensation benefits exert sufficient control over the corporation to lay themselves off or rehire themselves at will and are considered self-employed. -Courts have defined self-employed as members of a close corporation in which they retain a substantial amount of control after being laid off. This is public policy decision that said parties are not within the class sought to be benefited by the legislation. Cargill, v. Hedge Rule of Law- The corporate veil of a family farm corporation may be reverse pierced so that the owner-occupants of the farm by placing their land in the corporation do not lose their homestead exemption from judgment creditors.

Pepper v. Litton Rule of Law- Where a claimant in bankruptcy has dominated and controlled a corporation; his claim may be subordinated or even disallowed upon a showing that enforcement of the claim would be unfair to other creditors. Nissen Corp. v. Miller Rule of law- corporate successor liability does not include an exception for continuity of enterprise. More Piercing the corporate veil notes- Piercing the corporate veil can take one of two routes: (1) The corporation is the alter ego of its shareholders it is so dominated and used by them that in reality no separated entity is in existence. This is usually the case where the shareholders treat the corporations assets as their own, drawing upon company funds for their personal use at will (2) Recognizing the corporation as a legal entity would be to sanction a fraud or injustice. In these instances, where this approach is used, the purpose of incorporating was to prevent creditors from reaching personal debts, to run up debts in excess of assets, or, as charged in the present case, to minimize expected tort liabilities. (3) Although courts are willing to pierce the corporate veil to hold an individual responsible for corporate debt, they are even more willing to pierce the corporate veil to hold a parent corporation responsible for the debt of a subsidiary whose stock it holds. (4) Courts draw a distinction between tort and contract claims when determining whether to pierce the corporate veil. The rationale for not piercing the veil in contract disputes is that contract claimants usually deal voluntarily with the corporation, and thus willingly assume the risk of loss. Moreover, if the contract creditor is concerned with the financial viability of the corporation, he has the alternative of securing a guarantee. In contrast, tort claimants are typically involuntary creditors, and thus should not be made to assume the risk of loss thrust upon them by and undercapitalized corporation. (5) State courts have developed a variety of tests designed to guide courts in determining when the corporate veil should be pierced. All however tend to embody some sort of domination or abuse requirement and require proof of injustice should limited corporate liability be permitted. (6) The motive of the incorporator is immaterial Therefore; incorporation cannot be attacked because the incorporators sole motive was to save taxes or to avoid personal liability. No legitimate business purpose is required. A person is free to adopt whatever form he desires, so long as he observes the formalities associated with his choice. There must be a compelling policy reason for piercing the form if statutory authority to do so is not granted. (7) A reverse piercing claim may be brought by either the corporate insider, as was the case here, or by one with a claim against the corporate insider. In either case, the corporation is disregarded so that the corporate insider and the corporation are treated as one. As the court and critics have noted however, there is the danger that a debtor will be able to use the corporation to escape personal liability while also using the reverse piercing doctrine to prevent creditors from reaching the corporations assets. The courts answer to this danger is that a reverse pierce should be permitted in only the most carefully limited circumstances. (8) As the court intimates, the policy considerations involved in the imposition of successor 4

liability must be carefully balanced. On the one hand imposition of successor liability makes the alienability of assets more difficult. On the other hand there is the omnipresent risk that corporate assets will be sold for less than fir consideration or that the proceeds of the sale will be siphoned off by the shareholders. Thus the interests of creditors, including tort victims, must be adequately balanced against the interests of the shareholders. Successor Liability: (1 buys another ) If one corporation buys the assets of another - it is not generally liable for the debts or torts of the other corporation. However, some courts have held such a purchasing corporation liable where a. A Merger or Consolidation; b. Successor is a mere Continuation of the Predecessor, or c. Fraud or not made in good faith. Shares of a Corporation: Articles of Incorporation Specifies # of shares and rights of shareholders - Modification of the Statutory Scheme by Provisions in the Articles of Incorporation. The Statutes of many states permit the authority normally placed in the board of directors to be vested in other persons or organizations by an appropriate provision in the articles of incorporation (or in some instances for some types of provisions, in the bylaws). Many of these statutes also provide that if managerial authority is vested in person or organizations the duties, responsibilities, and liabilities of directors. Two states expressly permit shareholders to do anything that the board of directors may do so long as they act with the consent of all the shareholders. - Board of Directors: o Approve the Issuance of Shares o Determine how much each share will sell for o Decisions are Conclusive Subscription for shares (A Contract to buy shares) is valid, enforceable and irrevocable for 6 months unless otherwise specified in the agreement. A call for payment (To pay for shares) must be uniform to all subscribers. -

Restrictions on the transfer of shares: o Enforceable between parties to the agreement, but o Not Enforceable to 3rd parties without knowledge of the agreement Unless:

(1) The restrictions are Noted Conspicuously on the Front or Back of the certificate, or (2)a) The agreement is Referenced thereon and (2)b) A Copy of the Agreement is available upon request from the corporation. [6.27]

Shareholders may agree: o To a right of first refusal, o Obligate the corporation or a shareholder to purchase their shares at a fixed price , or, at a formula price, o and/or require apcccccccccccproval of a transfer or prohibit a transfer except to a specific class of persons unless the agreement is totally unreasonable.

Preemptive rights - The shareholders right to purchase a proportionate amount of any new shares sold by the corporation. [6.30] (Common law frequently imposed preemptive rights on corporations but the MBCA does not do so) and Preemptive rights are not available unless provided for in the articles of incorporation or bylaws.

Stokes v. Continental Trust Co.- A corporation must allow a shareholder to purchase newly issued stock at the fixed price to allow him to keep his proportionate share of the stock. - This represents the common-law view on preemptive rights, or the right of first refusal of new issues of stock. The prevailing view is that these rights apply only to common stock. Katzowitz v. Sidler- Where new shares are offered in a closed corporation, existing shareholders who do not want to or are unable to purchase their share of the issuance are not estopped from bringing an action based on a fraudulent dilution of their interest where the price for the shares is inadequate. - Close Corporation- A corporation whose shares ( or at least voting shares) are held by a closely knit group of shareholders or a single person. - Although the courts are reluctant to fix prices at which corporate stock can be issued, they can find little justification for issuing stock far below its fair value. Generally , the only time stock can be issued far below its book value is when book value is not reflective of the actual worth of the corporation or where a publicly held corporation experiences difficulties floating a new issue. The Model Corporations Act, 26, provides that preemptive rights exist only to the extent that such rights are provided, if at all, in the articles of incorporation.

Dividend- The payment of earnings to a corporations shareholders in proportion to the amount of shares held Gottfried v. Gottfried- If an adequate corporate surplus is available for the purpose, directors may not with hold a declaration of dividends in bad faith. - Closely held Corporation- A corporation whose hares or at least voting shares are held by a closely-knit group of shareholders or a single person. - Minority stockholder- A stock holder in a corporation controlling such a small portion of those shares which are outstanding that its votes have no influence in the management of the corporation. - Closely held corporations are easily subject to abuse on the part of the dominant shareholders, particularly in the direction of action to compel minority stockholders to sell their stock at a sacrifice. Even in the absence of bad faith, the impact of dissension and hostility among shareholders usually falls with heavier force in a closely held corporation. In many such cases, a large part of stockholders assets may be tied up in the corporation. It is frequently contemplated by the parties, moreover, that the respective stockholders receive their major livelihood in the form of salaries as employees of the corporation. But the fact that the corporation is closely held will not cause the courts to give greater scrutiny to the validity of the majorities actions. Dodge v. Ford Motor Co.- Ordinarily, the directors of a corporation alone have the power to declare a dividend, but the courts will intervene to require that a dividend be paid if it is discovered that the refusal of the directors to do so is based in fraud or an intention to conduct the affairs of the corporation not for the shareholders. - The general rule, is there is no right to a dividend for any shareholder (except in those cases in which dividends are made mandatory for preferred shareholders, by the Articles of Incorporation, in cases in which proper sources are available. Dodge, is one of very few cases in which equity has ever considered a refusal to pay a dividend so improper and/or in such bad faith as to justify interference with the normal corporate decision process. Cumulative dividends - The accumulation of dividends that are not paid and must be paid before dividends may be paid to the common shareholders or other subordinated shareholders. Right of Redemption - the right of the corporation to redeem (purchase) shares issued without the shareholders consent. Conversion - The right of the holder of shares or debt to convert the shares or debt into another form of security. Preferred shares - Shares that have special rights such as preferential dividend, liquidation or voting rights. Par value - has no significant meaning today but at common law it was generally the original price at which the shares were issued and upon which creditors could rely for the purpose of determining 7

the initial capital of the corporation.

Distributions to the shareholders are allowed if: 1. The can pay its debts in the ordinary course of business, and 2. Assets > Liabilities and (Balance Sheet as adjusted) a. [6.40] (Look UP) b. Distributions include: i. The purchase of shares outstanding and ( but shares back from shareholders so they still have same % of business but less shares + Money better for taxes) ii. The payment of dividends. Determinations may be based upon reasonably prepared financial statements and/or on fair valuations. Shareholders: Shareholders - (1) elect the board of directors and (2) approve extraordinary transactions. [7.28] - Extraordinary transactions are: o (1) The SALE of all or substantially all (25% or more) of the assets of the corporation other than in the ordinary course of business [12.01], o (2) A MERGER with another corporation [11,04], o (3) An AMENDMENT of the articles of incorporation [10.03], and o (4) The approval of the DISSOLUTION of the corporation [14.02]. 1 share = 1 vote - Unless otherwise provided in the Articles of Incorporation, [7.21] - In person or proxy at any meeting. [7.22] - A proxy is revocable: Unless it states to the contrary and is coupled with an interest. [7.22] - Shareholders of record (Owners at a specific date) are entitled to vote, not the equitable owner of the shares. Voting trusts - valid for a 10 year period. [7.30] - (1) The trustee has title to the shares and - (2) votes the shares in accordance with the trust agreement. - (3) The trustee must furnish the corporation with a list of the beneficiaries of the trust and the shares held by each. Different from shareholder agreements b/c right to vote goes into the trust---shareholder agreement they just agree to vote a certain way.

Ringling Bros. v. Ringling- A group of shareholders may lawfully contract with each other to vote in such a way as they determine. - Voting trust- An agreement establishing a trust, whereby shareholders transfer their title to shares to a trustee who is authorize to exercise their voting powers - Corporation Law, Rev. Code 18- One or more stockholders may have a written agreement to deposit capital stock with a trustee for the purpose of voting as agreed for a period of time. Brown v. McLanahan- Under a corporate voting trust agreement, a trustee may not exercise powers granted in a way that is detrimental to the cestuis que trustent (i.e., actual owners of the voting shares); nor may one who is trustee for different classes favor one class at the expense of another. Voting agreements - valid if signed by the parties. - No limit for their duration. [7.31] - Each shareholder continues to hold title to the shares and to vote the shares. Shareholder Agreements: - Common Law - any agreement that infringed upon the right of the directors to control a corporation was invalid. - Today these agreements are valid where all the shareholders have agreed to be bound, absent a violation of some public policy. o The agreement may be set forth in the articles or bylaws approved by the shareholders or otherwise be in a writing signed by the shareholders. [7.32] o o Under the MBCA the shareholders may eliminate the board of directors and/or restrict the discretion of the board or officers. [7.32] o o Such agreements must be conspicuously noted on the stock certificate or referenced thereon and a copy be made available from the secretary to be binding on a purchaser of shares. [7.32] Board of Directors: - the power to manage or direct the affairs of the corporation is with the board of directors. Absent an agreement to the contrary [8.01] The board serves the stockholders who may remove them with or without cause. [8.08] They continue to serve until their successors are elected. [8.05] They may delegate most decisions to committees of the board but may not issue a proxy to someone to vote for them. [8.25]

Officers: - have the authority that is given to them by the board of directors or by the bylaws or articles. [8.41] - However, 3rd persons have apparent authority to carry out the ordinary business of the corporation. - Resolutions of the board or the shareholders are set forth in the minutes of the corporation, which are kept by and certified to by the secretary. - Older statutes required a corporation to have a president, treasurer and a secretary. The MBCA no longer requires this. [8.40] Meetings of Shareholders and Directors: Quorum - necessary to conduct business at a shareholders meeting or a directors meeting. Quorum of shareholders = A simple majority of votes If no number is prescribed - a majority of directors = A quorum. If a number of directors is prescribed in the articles or otherwise - a majority of the number prescribed = a quorum of directors. (i.e. if there are 5 directors, you need 3 votes to adopt something, even if only 3 present, or 2 are dead, STILL NEED 3 At a shareholders meeting - a motion is approved if votes for it exceed the votes against it. Shareholders meeting - Once a quorum is present, it continues even though shareholders leave the meeting. At a directors meeting - a quorum must be present at all times in order to take action. o (Not Continuous) Election of Directors = by a Plurality (greatest number) of votes (Cant vote against someone, absent a special provision) To Adopt a Motion Majority of Directors must vote affirmative Cumulative voting - each person has votes = (# of Shares owned) x (# of directors to be elected), and May vote the entire number for one or divide it among any number of the nominees) Cumulative Voting - is not allowed unless provided for in the articles. Even where allowed, it is not authorized unless: (1) Notice of meeting conspicuously so states, or (2) A shareholder requests such right at least 48 hours before the meeting. Many states have begun to favor the cumulative voting method Only is effective if there is more than one director being elected

Humphrys v. Winous Co. Rule of law- A statute prohibiting restrictions upon the exercise of cumulative voting right should not be construed as guaranteeing minority representation on a

10

companys board of directors. -Section 1701.58 allows for cumulative voting -Section 1701.64 may provide for the term of office of all directors provided no term shall be more than 3 years from election. Ringling Bros v. Ringling Rule of Law- A group of shareholders may lawfully contract with each other to vote in such a way as they determine. - Corporation law code 18- one or more stockholders may have a written agreement to deposit capital stock with a trustee for the purpose of voting as agreed for a period of time - Voting trust- an agreement establishing a trust, where by shareholders transfer their title to shares to a trustee who is authorized to exercise their voting powers. Brown v. Mclanahan Rule of Law- Under a corporate voting trust agreement a trustee may not exercise powers granted in a way that is detrimental to the cestuis que trustent (i.e., actual owners of the voting shares); nor may one who is trustee for different classes favor one class at the expense of another. - Cestui Que Trust- Beneficiary; the party for whose benefit a trust is established. - Debentures- Long-term unsecured debt securities issued by a corporation. Lehrman v. Cohen Rule of Law- The creation of a new class of voting stock does not divest and separate the voting rights, which remain vested in the stockholders who creaed it, from the other attributes of the ownership of the stock. More Notes on Cumulative voting(1) Cumulative voting is designed to enable minority shareholders to secure some representation on a corporations board of directors. It permits a shareholder to cast his total number of votes for each director instead of casting one vote per share for each vacancy. (2) Generally a stockholder may exercise wide liberality of judgment in the matter of voting of his shares. It is no objectionable that his motives may be for personal profit, or determined by whims or caprice, so long as he violates no duty owed to his fellow shareholders. The remedy in the above case was made possible by Delaware law which permits the chancery court, when reviewing an election to reject the votes of a registered stockholder where his voting of them is found to be in violation of the rights of another person. (3) The Brown Case illustrates the general rule regarding voting trust. Although at common law such trusts were not recognized, most states now recognize their validity. Most states though, require the trust to be written and filed with the corporation, and most states limit the duration of such trusts to 21 years. Note that under such a trust the shareholder turns over his right to vote to a trustee, but he maintains his right to dividends, to inspect corporate records (for proper purposes), and to bring derivative suits. Furthermore as the Brown Case illustrates, the shareholder can bring an action against the trustee if he uses the shares to the shareholders detriment. (4) To be upheld, a voting trust or a pooling agreement must be created for a legitimate 11

purpose. Some legitimate purposes are to aid in reorganization, to fulfill some bona fide corporate policy, or to prevent rival concerns from gaining control of the corporation. However, a voting trust or pooling agreement will not be upheld where it is established to gain control by minority shareholders, to guarantee employment or salaries for management, or to freeze domination in a incumbent group or protect a minority interest in the corporation. Action by Directors and Officers In the Matter of Drive-In Development Corp.- Statements of a corporate officer, if made while acting within the scope of his authority, are binding upon the corporation. - Ostensible Agency- The apparent authority granted to an agent to act on behalf of the principal in order to effectuate the principals objective. - A corporation may be bound by the statements, agreements, etc., of one of its officers or directors who appears to outsiders to be acting pursuant to authority duly conferred upon him by the board of directors. Such ostensible authority may result from either the actions or representations of the officer himself or from the corporations failure to disclaim his authority to act. The corporation will not be bound by the unauthorized acts of one of its officers unless the outsiders belief that the officer possessed the requisite authority was a reasonable one. And, of course, and outsider who had actual knowledge of the officers lack of authority may not bind the corporation. Lee v. Jenkins Bros.- A president has authority only to bind his company by acts arising in the usual and regular course of business but not for contracts of an extraordinary nature. - Generally a president can hire and discharge employees and fix their compensation, but employment contracts for life or on a permanent basis are generally regarded as extraordinary nature and unauthorized. - Pension agreements are for the most part not considered unreasonable: it is necessary and beneficial to the corporation and is a common corporate fringe benefit. Unlike the case with life employment contracts, courts have often gone out of their way to find pension promises binding and definite even when labeled gratuitous by the employer - The general reasons for finding a contract extraordinary include the following: (1) An undue restriction of shareholder power and that of future boards on questions of managerial policy (2) An undue subjection of the corporation to an inordinately substantial amount of liability (3) A long and indefinite running period Transactions in Controlling Shares DeBaun v. First Western Bank and Trust Co.- A controlling shareholder owes a duty to his corporation, when selling his control in the corporation, of reasonable investigation and due care when possessed of facts establishing a reasonable likelihood that the purchaser of control intends to loot the corporation. 12

Duty of Reasonable Care- Duty to exercise the degree of care as would a reasonably prudent person under like circumstances. Despite early rulings where controlling shareholders owed little duty to minority shareholders it has been recognized as a fact of financial life that corporate control by ownership of a majority of shares may be misused. Thus applicable proposition now is that in any transaction where the control of the corporation is material, the controlling majority shareholder must exercise good faith and fairness from the viewpoint of the corporation and those interested therein.

Perlman v. Feldmann- A corporate director who is also a dominant shareholder stands, in both situations, in a fiduciary relationship to both the corporation and the minority stockholders if selling controlling interest in the corporation is accountable to it (and the minority shareholders) to the extent that the sales price represents payment for the right to control. (Dissent)- Justice Swan points out that the majority does not clearly delineate what fiduciary duties are owed as directors, and what duties are owed as controlling stockholders. Further, ignoring the lass of Feldmann plan benefits, he sees no detriment to the minority here in permitting the sale to Wilport. - A corporate director, who is also a dominant shareholder, stands, in both situations, in a fiduciary relationship to both the corporation and the minority stockholders (as beneficiaries of the fiduciary relationship), and, where such a director-shareholder sells controlling interest in the corporation, he is accountable to it and the minority shareholders, thereby, to the extent that the sales price represents payment for the right to control - This case points up the clear trend of authority, which attributes liability to controlling stockholders for sale of corporate control. Note the manner of proof here, the fact that control was the object of Wilport is to be inferred from the fact that they obviously bought so as to avoid the Feldmann plan of business. It was clear that Wilport had little reason to care about Newport progress and every reason, in the steel shortage, to take Newport for all its worth, forcing it to operate at little or no profit. As such, this case may be viewed as a further step in protecting minority stockholder interests from abuse Oppressive Conduct: If Controlling Shareholders frustrate legitimate expectations of minority shareholders = Ct. Ordered Dissolution. (Historically) Other Remedies: o Ordering one group of shareholders to buy out the others o Appointing a neutral director to break tie votes.

Oppressive Actions may include: - Excluding one group of stockholders from representation on the board of directors, - Eliminating a shareholder as a paid officer, - Suppression of dividends - Other actions intended to coerce a minority shareholder to sell his or her shares. 13

The courts often view these closely held corporations more like partnerships. Ordinarily this is not an issue in publicly held corporations.

Dissolution of a Corporation by request of a shareholder - May be done if: (1) The directors are Deadlocked AND Irreparable Injury to the corporation is threatened or is being suffered or where the corporation can no longer be conducted for the benefit of the shareholders; (2) The directors or those in control are acting or threatening to act in a manner that is illegal, oppressive or fraudulent; (3) The Shareholders are deadlocked at (2) Two Successive Annual Meetings AND Cannot elect a new board of directors, or (4) The corporations assets are being misapplied or wasted. Normally a controlling shareholder has no fiduciary duty to the minority shareholders with respect to the voting of or sale of his shares. However, he may incur liability if he sells to someone who he knows or reasonably should have known would loot the corporation, or according to some courts, where he obtains an economic advantage through the sale that should properly belong to the corporation as a whole. Derivative Actions: Distinguish Derivative, Class Action, A derivative action is one brought by a shareholder on behalf of the corporation. In order to be eligible to bring such an action, the shareholder (a) must have been a shareholder at the time of the act complained of, (b) be able to adequately and fairly represent the class, (c) have made a written demand on the corporation to bring the lawsuit and either received no response for 90 days or have received a rejection. [7.40-7.45] - (Demand is excused if it is absolutely independent) The board of directors has a right to govern the corporation including: (1) The right to determine whether to pursue a legal claim. o A derivative suit will be dismissed by a majority vote of independent directors, who constitute a majority of directors, or o By majority vote of a committee of independent directors (at least 2), who 1. Were appointed by the Independent directors, 2. If they determine in good faith after reasonable inquiry that the action is not in the best interest of the corporation. 14

Independent Directors - means there is no financial, family or other relationship that would have a material effect on the directors decision. - A director that was elected to the board by a controlling stockholder, - with respect to whom the questionable action relates, - who is named as a defendant, or - that a director voted for the transaction being challenged, does not by itself eliminate independence. Futility = Not enough Independence to make an unbiased decision. If a Shareholder claims Futility: (1) The complaint must allege specific facts establishing futility (the non-independence of directors or facts establishing gross negligence). (2) Where the corporation seeks dismissal of an action as not being in the best interest of the corporation where demand futility has been established, (3) The corporation must establish the independence of the directors making the determination and their due care in making the determination that the suit is not in the best interest of the corporation. Officers and Directors Fiduciary Obligations: Officers and directors must act: (1) Good Faith (with honesty), (2) Loyalty (in a manner they reasonably believe is in the best interest of the corporation, including having no conflict of interest that would preclude such), and (3) Due care (the business judgment rule). To recover from Breach must still show: Causation; Damages Due care - is determined based upon the process involved in making the decision. - It requires that the directors be adequately informed and be attentive (devote timely attention to corporate matters of concern). - Some courts hold that gross negligence constitutes a violation of due care.

The corporate opportunity doctrine (Duty of Loyalty). Best interest of . 2 part test: (1) Whether the opportunity is in the line of business of the corporation and (2) Whether the corporation has the financial means to execute the transaction.
-

Only when corporate opportunity taken advantage of by officer

15

Liability of directors may be eliminated in the articles of incorporation except: (1) For obtaining improper financial benefits (breach of duty of loyalty), (2) Inflicting intentional harm to the corporation, (3) Authorizing unlawful distributions, and (4) Intentional violations of the criminal law.

A conflict of interest transaction: may be approved where: (1) The director fully discloses to the other directors the existence and nature of the conflict and (2) All known material facts related thereto, and (3) The disinterested directors (or a properly appointed committee thereof) or shareholders approve the transaction. The director may also defend such a transaction by establishing that it was fair to the corporation. Indemnification of directors: is permissible except where: (1) Elimination of liability would not be allowed. (2) Mandatory indemnification for expenses of defense is required if the director wins on the merits or otherwise. (3) A termination of a suit by judgment, order, conviction or plea of nolo-contendre is not by itself determinative of eligibility for indemnification. (4) The corporation may advance expenses to a director with a written undertaking of the director to indemnify the corporation if it is subsequently determined that the director is not entitled to indemnification. The corporation may purchase insurance to protect the directors, whether or not the corporation could indemnify them or advance expenses to them. Shareholders Right to Corporate Records: Corporations must keep as permanent records: (1) Its articles, bylaws, minutes of shareholders and directors meetings, shareholder lists and proper accounting records. (2) Shareholders are entitled to inspect articles, bylaws, shareholders minutes and directors minutes to the extent they describe shareholders rights. (3) With respect to other minutes of directors, shareholder lists and accounting records, demand must be made in good faith and for a proper purpose. (4) Some states require that an annual financial statement be furnished to shareholders. [Shareholder lists are required to be available before shareholder meetings.]

16

Federal Securities Fraud. It is unlawful to use or employ in connection with the sale or purchase of a security any manipulative or deceptive device Rule 10b-5 makes it unlawful to: (a) use a device, scheme or artifice to defraud, (b) make an untrue statement of a material fact or omit to state a material fact necessary to not mislead, or (c) engage in any practice or act that operates as a fraud or deceit, in connection with the sale or purchase of a security. The rule makes conduct criminal and the courts have authorized civil actions for the recovery of damages. The USSC has required scienter (bad faith) and a knowing violation for criminal conviction. The rule has been interpreted to extend to the failure of insiders to disclose to stockholders material information prior to purchasing shares of a corporation. It has been extended to tippees and to others who learn of inside information and use it to their advantage. However, the USSC has stated that there must be a fiduciary obligation or obligation of trust and confidentiality owed by the tippee to the source of the information, to his employer or someone else not to use the information before the tippee may be held criminally liable. (Misappropriation theory.)

17