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CORPS TEACHING HYPOTHETICALS By Richard D. Freer Six fact patterns: 1. Organization of Corp 2. Issuance of stock 3.

Directors & officers 4. Shareholders 5. Fundamental corporate changes 6. Federal securities Fact Pattern 1: ORGANIZATION OF CORPS I. FORMATION REQUIREMENTS ((A) People, (B) Paper, (C) Act)(1) People: Incorporators. Must have 1 or more. What does incorporator do? Sign & file articles. Who can have this Job? Can BAR/BRI, Inc. serve as incorporator for Beauty Supply Corp.? Can Joan Rivers? Yes it can be a person or entity, thats majority view. In some juris, it has to be natural persons. (2) Paper: Articles of InCorp Articles are K btwn: (1) Corp & SHs (2) Corp & state. (1) Info in Articles (1) Names & Addresses. a. Corporate Name. Can I form Corp w/ name Bubbas Bountiful Biscuits? No. It must include one of these magic words: Corp, Company, incorporated or Limited, either spelled-out or abbreviated. Del has others. b. Names & Addresses of Incorporators & Initial Directors. Name of registered agent & address of registered office (registered agent is Corps official legal representative e.g., can receive service of process, to get PJ over Corp). (2) Statement of Duration (can be perpetual). (3) Statement of Purpose. a. General Statement of Purpose- Can articles of Bubbas Biscuits, Inc. indicate Corps purpose is to engage in all lawful activity, after 1st obtaining necessary state agency approval? Yes. In modern acts, if you have to make statement, it can be general. b. Specific Statement of Purpose & Ultra Vires RulesWhat if articles of Bubbas Biscuits, Inc. indicate Corps purpose is to sell Southern-style sausage biscuits & Corp later sells T-shirts as well as biscuits? Selling T- shirts is ultra vires act (beyond scope of articles, articles are contract w/ state, when you go beyond its ultra vires). At common law, contract could be voided as beyond Corps capacity. How do we handle ultra vires today? (1) Ultra vires contracts are valid. (2) SHs can seek injunction, to stop it. (3) Responsible O & D, are liable to Corp for ultra vires losses. Ex. Specific state of purpose, beyond state of purpose. (4) Capital Structure (stock).

a. Definitions of background terms: Authorized stock: max # of shares Corp can sell. Issued stock: # of shares Corp actually sells. Outstanding stock: shares that have been issued & not reacquired by Corp. b. Articles must include: (1) Authorized stock, (2) number of shares per class & (3) info on par value, (4) voting rights & (5) preferences of each class (3) Act- File articles w/ Secy of State & pay required fee. Acceptance by Secy of State is conclusive proof of valid formation. At that point, its a de jure (legal) Corp. Then, Board holds organizational meeting, where selects officers & adopts any bylaws & conducts other appropriate Biz. II. LEGAL SIGNIFICANCE OF FORMATION OF CORP (1) Internal affairs of Corp (e.g., roles & duties of directors, officers, & shareholders) are governed by law of state of inCorp. Even if you dont do Biz in state. (2) Corp is a separate legal person. It can sue & be sued, hold property, be a partner in a partnership, make charitable contributions, must pay income taxes as entity, etc. Disadvantage Corp level, double taxation. Advantages: (3) Generally, officers & directors arent personally liable for what entity does. Generally, shareholders (owners) arent personally liable for debts of Corp. Principle of limited liability, which means that shareholders generally are liable only for price of their stock. Biggest advantage of Corp form. (4) So whos liable for what Corp does? Corp as entity form. That means that if proprietors fail to form a de jure Corp, they will be nervous b/c theyll be liable for what Biz does. Liable as partners. Then, think about: Have to be unaware of de jure Corp. III. DE FACTO CORP DOCTRINE/CORP BY ESTOPPEL Doctrines by which a Biz failing to achieve de jure corporate status nonetheless is treated as Corp (so shareholders wont be personally liable for Biz debts). Generally, person asserting either must be unaware of failure to form de jure Corp. (1) De Facto Corp: (a) theres a relevant incorp statute; (b) parties made a good faith, colorable attempt to comply w/ it; & (c) some exercise of corporate privileges. If applicable, treated as Corp for all purposes except in an action by state. Ex: incorporators draft articles & mail them to Secy of State. Unbeknownst to them, papers are lost in mail. Theyre acting as a Corp in interim, not knowing of failure to form a de jure Corp. They have Biz enter contract. Are they liable on contract (since theres no de

jure Corp)? Yes, unless, Corp applies de facto Corp. They failed to file de jure Corp, theyre liable on these deals, unless court applies de facto corp. (2) Corp by Estoppel: one dealing w/ a Biz as a Corp, treating it as a Corp may be estopped from denying Biz corporate status. May be invoked against those who dealt directly w/ the Biz as a Corp. May also be used to prevent company from avoiding an obligation by asserting its own lack of valid formation. Usually available in contract, not tort, cases. Ex. You cant sue if you thought it was Corp. (3) Status of these 2 doctrines: Abolished by many states, still in many other states. IV. BYLAWS (1) In most states, adoption of bylaws isnt a condition precedent to formation of a Corp. But virtually every Corp has them. They are for internal governance e.g., lay out responsibilities, set regular meeting times & places, prescribe methods of giving notice. Stupid Questions. (2) Who adopts initial bylaws? Board of Directors, at organizational meeting. (3) Who can repeal or amend bylaws of a Corp? Shareholders, in some states, board can do so also. (4) If bylaws conflict w/ articles, articles control. Bylaws are internal document, not filed w/ a state agency. V. PRE-INCORP CONTRACTS (Contract before InCorp) (1) Promoter- person acting on behalf of Corp not yet formed. For ex, promoter might enter a contract on behalf of a Corp-not-yet-formed. (2) Liability on Pre-InCorp Contracts. A. Liability of Corp: Corp isnt liable on pre-inCorp contracts until it adopts contract. HYPO: On Jan 10, P, acting as promoter for Corp not yet formed, leases a building from Trump & signs lease Oscar de la Rental Cars, Inc. On Feb 20, Oscar de la Rental Cars, Inc. is formed. Is Corp liable on contract? Yes, if it adopted contract. How can that happen? (1) Express - board of directors action adopting contract. (2) Implied Arises, if Corp accepts a benefit of contract. In hypo, if they moved into leased premises. B. Liability of Promoter- Unless contract clearly provides otherwise, promoter remains liable on pre-inCorp contracts until theres a novation- until theres agreement of promoter, Corp, & other contracting party that Corp will replace promoter under contract. Very harsh rule. HYPO: (Assume here contract says nothing about promoter liability.)

Will P be liable on lease if Oscar, Inc. is never formed? Yes, promoter will be liable. Will P be liable on lease if Oscar, Inc. is formed & adopts lease? Yes, promoter is liable until novation. Remember: Adoption makes Corp liable too, but doesnt relieve P, only novation does that. So on this fact pattern, both Corp & P are liable. VI. FOREIGN CORPS Rule: Foreign Corps transacting Biz in this state must qualify. (1) Foreign Corp is one incorporated outside this state. So is a Corp formed in FL foreign? Yes, if outside FL, we dont mean other country, we mean other state. (2) Transacting Biz means regular course of intrastate (not interstate) Biz activity. Not occasional or sporadic activity. (3) Qualify by getting a certificate of authority from Secy of State. Apply by giving info from articles & a certificate of good standing from home state. Must pay fees to state. Generally, must appoint registered agent here too. (4) Violation: Consequences of foreign Corp transacting Biz w/o qualifying: (I) civil fine & (II) Corp cant sue in state (but it can be sued). No other consequences for foreign Corp, contracts still valid. Can foreign Corp sue once it qualifies & pays fees & fines? Yes. FACT PATTERN 2: ISSUANCE OF STOCK I. WHAT IS ISSUANCE? Issuance of stock occurs when Corp sells or trades its own stock. Way to raise capital for Corp. Ex. Wal-Mart Corp. sells 10k shares of stock. Thats an issuance, b/c Corp is selling its own stock. Ex. Family Guy sells 3k shares of Wal-Mart stock. Issuance? No, only issuance if Corp sells own stock, doesnt apply if individuals sell stock. -- So that means that all these rules in this fact pattern apply only when Corp is selling its own stock. NOT when you or I sell stock. II. SUBSCRIPTIONS [written offers to buy stock from Corp] (1) Revocation of Pre-InCorp Subscriptions HYPO: On Jan 10, S signs a subscription, offering to buy 100 shares of C Corp., a Corp not yet formed. Week later, S changes his mind. Can S revoke? No. Pre-inCorp subscription is irrevocable for 6 mos unless it provides otherwise or all subscribers agree. (2) Are post-inCorp subscriptions revocable? Yes, until acceptance.

(3) When do Corp & the subscriber become obligated under a subscription agreement? When Board accepts offer, at that point we have a deal. III. CONSIDERATION-what must Corp receive when it issues stock? (1) Form of Consideration: split of authority on this. A. Every state agrees that these are permitted: (1) money (cash or check), (2) tangible or intangible property, or (3) services already performed for Corp. B. Split of authority is about 2 other forms. In some states these are OK but in some states theyre prohibited (so using them results in unpaid stock, meaning its all treated as water): (1) Promissory Note, (2) Future Services. Flag, in some states you can do this, in other state you cant do this. (2) Amount of Consideration. A. Par-minimum issuance price. Hypo: C Corp. is selling 10k shares of $3 par stock. It must receive at least $30k. Relevant in some states not others. B. No par- no minimum issuance price. Board of directors sets any price. C. Treasury Stock- This is stock that was previously issued & has been reacquired by Corp. Corp can then resell it. Treat sale as no par. D. Who determines value of consideration received for issuance? Board of directors. & its valuation is conclusive if it was made in good faith. (In some states, its conclusive if board acted w/o fraud.) E. Consequences of issuing par stock for less than par value; i.e., watered stock. Hypo: C Corp. issues 10k shares of $3 par to X for $22k. Corp (or its creditors if it is insolvent) wants to recover $8k of water. Who is liable? (1) Directors? Yes, if they knowingly authorized issuance, if so theyd be liable. (2) X (person who bought it)? Yes, liable. (3) What if X transfers the stock to A? A isnt liable if she acts in good faith (didnt know about water). -- But As status (good faith or not) has no effect on liability of X or directors. IV. PREEMPTIVE RIGHTS (1) Preemptive right is right of existing shareholder to maintain her percentage of ownership by buying stock whenever theres a new issuance of stock for money (cash or equivalent). Some states dont include sale of treasury stock as new issuance. Ex. S owns 1k shares of C Corp. There are 5k shares outstanding. C Corp. is planning to issue additional 3k shares. If S has preemptive rights, then S has right to: Buy 600 shares, 20% of new issuance.

(2) What if exam question doesnt indicate whether articles of C Corp. provide for preemptive rights? Split of authority. Traditionally, preemptive rights exist unless articles provide otherwise. Strong trend says preemptive rights dont exist unless articles provide for them. Hypo Articles of C Corp. provide for preemptive rights. C Corp. is issuing stock to G to acquire Green Acres from G. Are there preemptive rights? NO. Why? This isnt issuance for money, preemptive rights only attach for money. FACT PATTERN 3: DIRECTORS & OFFICERS I. STATUTORY REQUIREMENTS DIRECTORS (1) Number: 1 or more adult natural persons. (2) Election: Shareholders elect directors, annual meeting (3) Shareholders can remove directors before their terms expire. Generally, majority of shares entitled to vote must vote for removal. On what bases? W/ or W/o cause. Shareholders hire & fire. -- But shareholders cant remove a director if cumulative voting is in effect & number of votes against removal would be enough to elect director. We will see cumulative voting on page 24 . (4) Who selects person who fills a vacancy on Board? Board or shareholders. But if shareholders created vacancy by removing a director, shareholders generally must select replacement. (5) Board Action. A. 2 ways board takes valid act: (1) unanimous written consent to act w/o a meeting, or (2) a meeting (can be held anywhere) that satisfies quorum & voting requirements. What if neither of these is met? Any act by Board is void, unless its ratified by valid act. Does a conference call qualify as a meeting? Yes, dont have to be in same room, just able to hear at same time. B. Notice- required for special meetings but not regular meetings. (Time & place of regular meetings is set in bylaws.) Method for giving notice usually in bylaws. If Corp fails to give notice of special meeting to all directors, meetings void unless those not given notice waive defect. C. Are proxies or voting agreements OK for director voting? No, against public policy. Need directors to exercise independent judgment. Shareholders can have proxy. Look at what hat person is wearing. If shareholder is on Board of directors, they can give proxy for shareholder vote but not board vote. D. Quorum for Meetings. Need a majority of all directors to do Biz (unless bylaws require otherwise). If

quorum is present at meeting, to pass a resolution (how Board takes an act at a meeting) we need only majority vote of those present. -- So, if there are 9 directors, at least: 5 directors must attend meeting to constitute quorum. If 5 directors attend, at least 3 vote to pass resolution. II. ROLE OF DIRECTORS Must Vote Yes To (1) Board manages Biz of Corp., e.g., sets policy, selects & supervises officers, declares distributions, decides when to issue stock, recommends fundamental changes to shareholders. So note that shareholders dont run Corp. They elect directors, who run Corp. Owners are not necessarily managers unless theyre also on Board. Shareholders have no MGMT ability. (2) Board can delegate substantial MGMT functions to committee, but committee cannot: (1) amend bylaws, (2) declare dividends or (3) recommend fundamental corporate change to shareholders. Committee is subset of board, but can be just 1 member, but usually 2-3. III. DUTY OF CARE (Burden on Plaintiff) Duty of Care Standard: Director owes Corp duty of care. Must do what prudent person would do w/ regard to her own Biz. Prudent people do appropriate homework before making a decision. Did they deliberate, analyze, do research? If they dont do homework, theyll be liable, Ex. Smith v. Van Gorkham. (1) Nonfeasance (Director Does Nothing, Lazy). Hypo: Justin Timberlake, director of C Corp., fails to attend any board of directors meetings or keep abreast of company Biz in any way. Corp loses money on several deals. Will Justin be held liable for these losses for breaching duty of care? --State duty of care standard. Prudent person would attend some meetings & do some work. Justin never did anything, so he has breached duty of care. BUT HES LIABLE ONLY IF: His breach caused loss to Corp. Not enough to show theres been breach of duty of care. Also show causation, that Corp was hurt. Very hard burden to meet. Ex. Director is antitrust expert, & Board violated antitrust laws, but if she wouldve went to meeting she couldve prevented antitrust violations. (2) Misfeasance (Board Hurts Corp)Hypo: Directors of Hedonists Hot Tubs, Inc., vote to start new line of hot tubs w/ built-in wine coolers & video cameras. Idea is disaster & Corp loses money. Directors Liable for Breach of Duty of Care? State duty of care standard. Here, directors action caused loss to Corp. BUT, director isnt liable if she meets Biz Judgment Rule.

BJR: Court wont 2nd-guess Biz decision if it was made in good faith, was informed, & had a rational basis. Dont have to be right, just have to do HW, directors only liable if they were grossly negligent or irrational. IV. DUTY OF LOYALTY (Burden on Defendant b/c BJR doesnt apply in cases involving conflict of interest. Director putting own interest over Corp.) Duty of Loyalty Standard: Director owes Corp duty of loyalty. She must act in good faith & w/ reasonable belief that what she does is in Corps best interest. Model Act combines duty of care & duty of loyalty. Fact Patterns(1) Interested Director Transaction-any deal btwn Corp & 1 of its directors or another Biz of directors. Under Model act, this includes close relatives of director. Hypo: Martha is director of XYZ, Inc. She sells wreaths to Corp. Thats an interested director transaction. Is Martha in trouble? State duty of loyalty standard. Interested director transaction will be set aside UNLESS director shows: (1) deal was fair to Corp when entered, OR (2) her interest & relevant facts were disclosed or known & deal was approved by either of these: (I) Majority of disinterested directors, or (II) majority of disinterested shares, not shareholders, number of shares of shareholders. Vary from state to states but: Special Quorum Rules: interested directors count toward quorum. -- Directors can set their own compensation, but it must be reasonable. If excessive, its waste of corporate assets, & breach of duty of loyalty. If executive compensation is too much, its waste & breach of duty of loyalty. (2) Competing Ventures Hypo: Sharon is director of Oz Music Co. She can also serve on board of directors of ID b/c it doesnt compete w/ Ozzie's. But can Sharon start her own music Co? State duty of loyalty standard. Director cant compete directly w/ her Corp. Obvious breach. Remedy: Constructive trust on sharons profits, cough them up to Ozzies. (3) Corporate Opportunity (Expectancy). Hypo: Cheatem is director of C Realty Corp., which develops condo projects. Cheatem learns of some land that has been zoned for condos & buys it for himself as an investment. What are Cs rights, if any, against Cheatem? State duty of loyalty standard. Director cant USURP corporate opportunity i.e. director cant take it until he (1) tells board & (2) waits for board to reject opportunity.

What is Corporate Opportunity? 4 Tests (I) anything in Corps Biz line (Deleware Test), (II) something Corp has interest or expectancy in, (III) Did director find this on her own time or on Company time, during work hours, or weekend, (IV) Fairness- is it fair that director took this w/o offering it to Corp. Yes, it was in line of Biz, in fairness it seems like Corp opportunity. Is companys financial inability to pay for opportunity a defense? No, its generally not. Even if Corp couldnt afford it, & Board member couldnt. Remedy: If Cheatem still has it, he must sell it to Corp at his cost. If Cheatem has sold it at profit, Corp gets profit. (Constructive trust.) V. OTHER BASES OF DIRECTOR LIABILITY (1) Ultra Vires Acts- Responsible officers & directors are liable for ultra vires losses. Remember did this on page 2. (2) Improper Loans Hypo: Curly, Moe & Larry are directors of C Corp. Board of directors votes to lend Curly $100k of corporate funds. Generally, such loan is OK only if board finds that its reasonably expected to benefit Corp. Sarbanes-Oxley Act (fed law) prohibits most loans to executives in registered (publicly traded) Corps, really about financial accountability. (3) Improper Distributions. See page 24. (4) Which directors are liable for all the things directors can be liable for? General Rule-director is presumed to have concurred w/ Board action unless her dissent or abstention is noted in writing in corporate records. That means (1) in minutes or (2) in writing to corporate secy at meeting or (3) registered letter to corporate secy immediately after meeting. Is Oral Dissent Effective? Not by itself, has to be in writing. You cant dissent if you voted for resolution at meeting. B. Exceptions (1) Absent directors arent liable (2) Good faith reliance on (a) book value of assets or (b) opinion of a competent employee, officer, professional, or committee of which director relying wasnt a member, or (c) financial statements by auditors. Must have reasonable belief in competence of persons providing such info. VI. OFFICERS (owe same duties of care & loyalty as directors) (1) Status: Officers are agents of Corp. So they can bind Corp by acts for which they have authority to bind it.

Watch for agency issue, did she have apparent authority, actual authority, etc. -- President generally has inherent authority to bind Corp to contracts in ordinary course of Biz. What Officers are in Corp? Traditionally, must have Pres., Secy & a Treasurer. Can also have others. Today, can 1 person hold multiple offices simultaneously? Yes, most states let 1 person have all officer positions. (2) Selection & Removal of Officers- Officers are selected by & removed by directors. Directors also set officer compensation. Hypo: Directors of Pharmacy Inc. appoint Cruise as Pres. What happens if they fire him from presidency? Toms gone, although Corp may be liable for breach of contract damages. Can get money, but cant get job back. -- Shareholders hire & fire directors, but directors hire & fire officers. Generally, SH* DONT hire & fire officers. VII. INDEMNIFICATION OF DIRECTORS & OFFICERS (Every State has Statute) Hypo: Officer or director gets sued by or on behalf of Corp. Incurred costs (attorneys fees, fines, judgment or settlement). Seeks reimbursement from Corp. 3 Categories: A. No Indemnification; i.e., when is Corp barred from indemnifying? If held liable to Corp or held to have received an improper personal benefit. If either is true, Corp cant pick up tab. B. Mandatory Indemnification; i.e., when is Corp required to indemnify? In some states, if she was wholly successful (on merits or otherwise) in defending action. In others, to extent she was successful. If wholly successful, only get indemnification if she wins whole case. If it was to extent, shell get indemnification for counts she won on. C. Permissive Indemnification; i.e., whens Corp permitted to indemnify? Not required, both precluded. 1. Situations: anything not satisfying A. & B. above. Watch for settlement. 2. Eligibility Standards: she must show that she (I) acted in good faith & (II) w/ reasonable belief that her actions were in company=s best interests. Duty Of Loyalty 3. Who Determines Eligibility? Disinterested directors or disinterested shares or independent legal counsel. (2) Notw/standing rules, court where director or officer was sued can order indemnification if its justified in view of all circumstances. Usually limited to costs & attorneys fees (not any judgment against director or officer). (3) Articles can provide for limitation or elimination of liability for damages, but not for breach of duty of

loyalty, intentional misconduct or wrongful personal benefit. In some states, such provisions are available for directors only, not officers. FACT PATTERN 4: SHAREHOLDERS I. HOLDING SHAREHOLDERS LIABLE FOR ACTS OR DEBTS OF CORP (SHAREHOLDER AS DEFENDANT) Generally, a shareholder isnt liable for acts or debts of Corp. But a court might pierce corporate veil (PCV), which means court will hold shareholders personally liable for what Corp did. To do this, 2 things must be true: (1) shareholders have abused privilege of incorporating & (2) fairness requires it. PCV has only been used in close Corps, not public companies, just small. -- PCV Standard (when fairness requires piercing): to (I) avoid fraud or (II) unfairness. (PCV never automatic.) (1) Alter Ego (Identity of Interests) Hypo: X & Y are shareholders of C Corp. X is also CEO. X commingles personal & corporate funds, uses corporate car as his own, uses Corp credit card to pay for personal purchases. Can creditor of Corp unable to collect claim from Corp collect from either X or Y? General Rule (shareholders not liable for acts or debts of Corp). Then PCV standard (abuse, fairness requires it). Here a court MIGHT PCV if Xs failure to respect separate corporate entity harmed creditors. Sloppy admin generally isnt enough for PCV, but here X treated Corp as his alter ego by treating Corp & personal assets as interchangeable. Must harm creditors. -- If PCV on these facts, only X would be liable. Y has done nothing wrong. (2) Undercapitalization Hypo: S is shareholder of Glowco, Inc., G, a Corp that hauls & disposes of nuclear waste. G doesnt carry insurance. G has initial capitalization of $1k. V is injured when 1 of G=s trucks melts down. Can V sue S? General Rule: PCV standard. Here court MIGHT PCV b/c Corp was undercapitalized when formed. Why? B/c shareholders failed to invest enough to cover prospective liabilities, company didnt but insurance even though its dangerous biz. -- Instead of PCV here, Deep Rock Doctrine- court might subordinate debt owed to responsible shareholders (if any) to that of other creditors. Remember (always say this in PCV hypo): courts generally more willing to PCV for tort victim than contract claimant. II. SHAREHOLDER MANAGEMENT OF CORP (1) Generally board of directors manages Corp.

(2) Shareholders can manage Corp directly in close Corp. Characteristics of Close Corp? Few Shareholders, Stock isnt publicly traded. Not real Corp, but mom & pop deal. -- Shareholders in close Corp can elect board of directors, & board will manage Corp. Or they can eliminate board of directors & run Corp themselves. Usually, this is done by unanimous shareholder agreement. If shareholders eliminate board & take over MGMT, who owes duties of care & loyalty to Corp? Managing shareholders are fiduciaries. (3) Shareholders in close Corp owe each other fiduciary duties. Watch especially controlling shareholder who oppresses minority shareholders, e.g., selling control (w/o reasonable investigation of buyer) to someone who loots Corp or other oppression of minority shareholders. Courts may be willing to help minority shareholder here. WHY? B/c theres no public market for shares (so minority shareholder cant just get out by selling shares). Donna Hugh, Wilkes. Protective of minority shareholder. (4) Licensed professionals, including lawyers, medical professionals, & CPAs, may incorporate as professional Corp. Name must include designation Aprofessional Corp@ or Aprofessional association@ or abbreviation of 1 of those. Shareholders must be licensed professionals & generally P.C. may practice only one profession. P.C. may employ non-professionals (not to render professional services). Professionals & P.C. remain personally liable for own malpractice or misconduct in rendering professional services. Shareholders are generally not liable for each others malpractice or corporate obligations. Generally, rules governing regular Corps apply to the P.C. III. SHAREHOLDER DERIVATIVE SUITS (SH AS PLAINTIFF) (1) In derivative suit, shareholder is suing to enforce Corps claim, not her own personal claim. To determine if its a derivative suit, ask: could Corp have brought this suit? If so, its probably a derivative suit. Hypo: S sues board of directors of C Corp. for usurping corporate opportunities. Derivative suit? YES, duty of loyalty (and care) are owed to Corp. So breach hurts corp. Classic derivative suit. Know about derivative, & particular duties. Hypo: S sues board of directors of C Corp. for issuing new stock w/o honoring her preemptive rights. Derivative suit? No this is direct suit, to vindicate Ss personal claim.

(2) What consequences of successful derivative suit? Generally, recovery in any successful derivative suit goes to Corp (not to shareholder who brought suit on behalf of Corp. What Does S Receive? Costs & attorneys= fees, usually from Corp. After all, shareholder conferred benefit on Corp by suing & winning. (3) What are Consequences of Unsuccessful Shareholders Derivative Suit? Can SH still recover costs & attorneys fees? No. Is SH liable to people sued for their costs & attorneys fees? Yes, if suit w/o reasonable cause. Can Other SH later sue X on same transaction? No, its res judicata. (4) Requirements for bringing SH derivative suit? A. Stock Ownership- Person bringing suit must have owned stock at time claim arose or have gotten it by operation of law from someone who did own stock when claim arose. What are examples of operation of law? Inheritance & divorce decree, got it by law from someone who did own it. B. Must also show SH will adequately represent Interest of Corp. C. Must also make Written Demand on Directors that Corp bring suit UNLESS demand would be futile. Why would demand be futile? When these directors will be D* in case. D. Usually must plead w/ particularity the efforts to get Corp to sue or why demand was excused. E. Corp can move to dismiss derivative suit based on findings by disinterested directors (or committee of disinterested directors) that suit isnt in Corps best interest (e.g., low chance of success or cost of litigation would exceed recovery). -- Court will scrutinize whether directors making recommendation are truly disinterested and, if so, dismiss. In some states, court will also make independent determination of whether dismissal is in Corps best interest. (5) Litigation A. Corp must be joined as D*. Even though suit asserts Corp's claim, Corp didnt do so, so its joined initially as D*. B. No dismissal or settlement w/o court approval. Court can give notice to those who would be affected, & get their input on whether dismissal or settlement should be approved. IV. SHAREHOLDER VOTING (1) WHO VOTES? General rule is that record shareholder as of record date has right to vote.

A. Record Shareholder is person shown as owner in corporate records. Record date is voter eligibility cut-off. Hypo: C Corp. sets its annual meeting for July 7 & record date for June 6. S sells B her C Corp. stock on June 25. Who is entitled to vote shares at meeting, S or B? S, b/c she owned it on June 6th, which was record date, even if they no longer own it on June 25th. B. Exceptions to General Rule that Record Owner on Record Date Votes 1. Treasury Stock. Suppose Corp reacquires stock before record date. So Corp is record owner on record date of this treasury stock. Does Corp vote treasury stock? No. 2. Death of Shareholder- S owns stock in C Corp; S is record shareholder. After record date, S dies. Can Ss executor vote shares? Yes, dead people cant vote, so executor can. 3. Proxies- is (i) writing (fax increasingly OK; e-mail OK in some states), (ii) signed by record shareholder, (iii) directed to Secy of Corp, (iv) authorizing another to vote shares. -- On Feb 2, 07, S sends letter to secretary of C Corp. authorizing Ed to vote her shares. Can Ed vote S=s shares at 07 annual meeting in July? Yes. -- This is OK in shareholder voting. Remember, proxies are not permitted for voting by directors. Page 9, look at what hat person is wearing. Can Ed vote Ss shares at July 08 annual meeting? Good vote for 11 mos unless it says otherwise. What if, prior to 07 meeting, S writes secy of C Corp. that she now wants Jim to vote her shares at 07 meeting? Yes, she revokes Ed proxy. Can S revoke her proxy even though it states its irrevocable? Yes, you can still revoke. Hypo: S sells B her shares after record date but before annual meeting. S gives B an irrevocable proxy to vote shares at annual meeting. Can S revoke this proxy? No, b/c (1) it says irrevocable & (2) proxyholder has some interest in shares other than voting. This is a proxy coupled w/ an interest (Only way to have irrevocable proxy). -- Here, interest is ownership. But it could be an option, pledge, etc. C. Voting Trusts & Voting AgreementsHypo- X, Y, & Z own relatively few shares of C Corp. They decide that they can increase their influence on corporate policy by block voting, i.e., voting alike. 1. Requirements for Voting Trust. A. Written trust agreement controlling how shares will be voted; B. Copy to Corp; C. Transfer legal title of shares to voting

trustee; D. Original shareholders receive trust certificates & retain all shareholder rights except for voting. (10 year max, in most states). 2. Requirements for Voting (pooling) Agreement (Not Trust). A. Can shareholders enter into voting agreements? Yes. B. What is required? In writing & signed. C. Are voting agreements specifically enforceable? Split of authority, some states yes, some no. Model Biz act, are enforceable. (2) WHERE DO SHAREHOLDERS VOTE? A. 2 Ways SH take valid Corporate Act: (1) unanimous written consent of the holders of all voting shares, or (2) a meeting (held anywhere) that satisfies quorum & voting rules. B. Annual Meeting: to elect directors. If not held, a shareholder can petition court to order one. C. Special Meeting can be called by (a) Board, (b) Pres., (c) holders of at least 10 % of voting shares or (d) someone else as provided in articles. Hypo-- Suppose proper person calls a shareholder meeting for purpose of removing an officer. Is there a problem w/ this? B/c Shareholders dont remove officers. Meeting of shareholders must be for proper purpose, cant remove officers, just directors. D. Notice Requirement must give written notice to every shareholder entitled to vote, for every meeting (annual or special). 1. Contents of Notice: always must tell them (I) when & (II) where & (III) must state purpose. Why is statement of purpose important? Because that is the only Biz that can be transacted at that meeting. 2. Consequence of Failure to give proper notice to all shareholders action taken at meeting is void unless those not sent notice waive notice defect. How Does Waiver Occur? (1) Express- in writing & signed any time; or (2) Implied- attend meeting w/o objection. (3) How do shareholders vote? Must be a quorum represented at meeting. Determination of quorum focuses on number of shares represented, not number of shareholders. Generally, a quorum requires a majority of outstanding shares. Hypo-- X Corp. has 120k shares outstanding. X Corp. has 700 shareholders. What or who constitutes quorum? 60,001 shares, would give quorum. Need majority of shares, not SH. -- If quorum requirement is met, a majority may act to bind Corp unless articles or bylaws require higher vote. But majority of what shares present or shares actually

voting? Just majority of those actually voting, not present. Hypo- X Corp. has 120k shares outstanding. 62k shares are represented at meeting, but only 50k shares vote on particular proposal. How many shares must vote for proposal for it to be accepted by shareholders? 25,001 (2) How & When do SH use Cumulative Voting? A. Cumulative Voting only available in voting for directors. Its a device to give small shareholders a better chance of electing someone to Board. B. Multiply number of shares times number of directors to be elected. Hypo: You own 1k shares of stock in C Corp. C Corp. has 9 directorships open for election. You believe that Napleon should be director of C Corp. Under cumulative voting, how many votes can you cast for Napoleon? 9k. Split them up anyway you like. Cumulative voting is at large. C. Articles of C Corp. are silent as to whether shareholders can vote cumulatively. Can Cs shareholders still vote cumulatively? Generally no, but this exists in most states only if articles provide. V. STOCK TRANSFER RESTRICTIONS 1 nice thing about stock is that its freely transferable you can sell it, will it, give it away. Sometimes people want to impose restrictions on transferability of stock. Often, this is in close Corp, to keep outsiders out. Hypo: Federline is a shareholder of Famous For No Reason, Inc. His stock is subject to stock transfer restriction that requires him to offer it 1st to Corp (this is a right of 1st refusal). Federline sells the stock to Paris Hilton in violation of agreement. Breach of Agreement. A. Stock transfer restrictions will be upheld provided theyre reasonable under circumstance, which means not undue restraint on alienation. Right of 1st refusal is OK, assuming Corp offers reasonable price. B. Action against transferee of stock. Even if restriction is reasonable & thus valid, it cant be invoked against transferee unless either (A) its conspicuously noted on stock certificate or (B) transferee had actual knowledge of restriction. I. RIGHT OF SH (PERSONALLY/AGENT) TO INSPECT (& COPY) BOOKS & RECORDS OF CORP (1) Standing: who can demand access? Generally, any shareholder. (2) Procedure: written demand stating proper purpose, which means: purpose, related to her role as shareholder, for ex. Hostile MGMT. RUPA- some documents dont need proper purpose: ex.articles of inCorp.

(3) Consequences if Corp doesnt allow inspection after proper demand? Shareholder moves for court order. If successful, also generally recovers costs & attorneys fees incurred in making motion. (4) Directors dont have to make any showing to get access to books & records. B/c of their MGMT responsibilities, they have unfettered access. VII. DISTRIBUTIONS (Payments to SH can be (1) dividend or (2) to repurchase a shareholders stock or (3) to redeem stock (redemption is forced sale to Corp at a price set in articles). (1) Distributions are to be declared in Board s discretion. Action to compel declaration of distribution is tough to win. Can win only on very strong showing of abuse of discretion. For ex, if Corp consistently makes profits & board refuses to declare dividend while paying themself bonus. (2) Which Shareholders get Dividends? (Preferred, Participating, Cumulative, Common) Hypo: Board of directors of C Corp. decides to declare dividends totalling $400k. Who receives dividends if outstanding stock is: 1. 100k shares of common stock- $ 4 per share. 2. 100k shares of common & 20k shares of preferred w/ $2 dividend preference. Preferred means pay 1st. 20k preferred shares multiplied by $2 preference equals a total preference of $40k. $40,000. That is paid first. That leaves $360k, which goes to common shares. Because there are 100k of those, each common share gets $3.60. 3. 100k shares of common & 20k shares of $2 preferred that is participating. Participating means pay again. So these 20k shares get paid 1st (b/c theyre preferred) & also get paid again (b/c theyre participating). Work preferred aspect same as in hypo #2: 20k shares multiplied by $2 equals $40k total preference. Pay that 1st. That leaves $360k, as in hypo #2. But here, $360k gets divided by 120k shares. $3 a share, & $2 for preferred stock. Get to go back twice. 4. 100k shares of common & 20k shares of $2 preferred thats cumulative (& no dividends have been paid in 3 prior years).Cumulative means add them up. Cumulative dividend accrues year-to-year. So Corp owes cumulative holders for 3 prior years, plus this year (when dividend was declared). That means Corp owes them 4 years= worth of a $2 preference. 4 years multiplied by $2 equals $8 per share. So Corp owes $8 to each cumulative preferred share. There are 20k such shares. 20k shares X $8 per share= $160 k, which leaves rest to common.

(3) For Any Distribution (Dividend, Repurchase, Redemption), Which Funds Can be Used? Fund Limitation 1. Earned surplus: Generated by biz activity. A. Hows Earned Surplus Computed? All earnings minus all losses minus distributions previously paid. Making money in real world. B. How can earned surplus be used? Is proper fund for distribution, in discretion of board. 3. Stated Capital: generated by issuing stock. (So is capital surplus, below.) So when we have issuance of stock, consideration will be allocated btwn stated capital & capital surplus. A. Can Stated Capital be used for distributions? No B. How is stated capital computed? -- C Corp. has issued 10k shares of $2 par stock for $50k. $20k to stated capital & $30k to capital surplus. Why? On a par issuance, par value goes to stated capital. Here $20k, b/c sold 10k shares of $2 par & excess over par goes to capital surplus here $30k. If we had a no-par issuance, board allocates consideration btwn stated capital & capital surplus. 3. Capital surplus: this is also generated by issuing stock. A. How is Capital Surplus Computed? Payments in excess of par plus amounts allocated on a no-par issuance. B. Can Capital Surplus be Used for Distributions? Yes, if you inform shareholders. (4) Instead of foregoing fund requirements, many states now simply say Corp can declare distribution as long as Corp isnt insolvent or if distribution would render it insolvent. Insolvent means either: (I) Corp is unable to pay debts as they come due OR (II) its assets are less than its liabilities (and liabilities include liquidation (or dissolution) preferences); we will see liquidation preferences on page 29. (5) Directors are personally liable for unlawful distributions, as are shareholders who knew distribution was unlawful when they received it. In some states, director liability here is strict; in some, directors are only liable if distribution is made in breach of a duty. Remember, however, directors possible defense of good faith reliance. FACT PATTERN 5: FUNDAMENTAL CORPORATE CHANGES I. CHARACTERISTICS OF FUNDAMENTAL CORPORATE CHANGE (1) Unusual occurrences, so they require board of director action and

(2) Approval by- a majority of shares entitled to vote. Tougher than regular quorum requirements. So this is different from shareholder voting before. Here its not enough to get a majority of shares present or that actually vote we need a majority of those entitled to vote. (3) Possibility of dissenting shareholder right of appraisal. A. Right of appraisal is right of a shareholder to force Corp to buy her shares at fair value. This is shareholders sole remedy for these fundamental changes unless there is fraud. B. When will a shareholder have a dissenting shareholder right of appraisal? 1. Actions by Corp to trigger right -- any of these: A. merger or consolidation; B. transfer of substantially all assets not in ordinary course of Biz; C. transfer of shares in a share exchange. 2. Actions by shareholder to perfect right: A. Before shareholder vote, file with Corp written notice of objection & intent to demand payment; B. Abstain or vote against proposed change; & C. After vote, make written demand to be bought out. C. If shareholder & Corp cant agree on fair value of shares, what happens? D. Some states dont grant right of appraisal if companys stock is listed on national exchange or has a large number of shareholders (e.g., 2,000 or more). This makes sense, b/c in such a large Corp, theres a public market for shares, so disgruntled shareholder can just sell on market. She doesnt need to force Corp to buy her out. II. AMENDMENT OF THE ARTICLES (1) Board of director action & notice to shareholders. (2) Shareholder approval. Hypo: If there are 4k outstanding shares entitled to vote, how many must vote for Amd? 2,001 What if only 2,400 shares showed up to vote on the Amd? Still need 2,001, need majority of shares entitled to vote, not just majority of shares that show-up. (3) If approved, file amended articles w/ Secy of State. (4) Are there dissenting shareholder rights of appraisal? No. But if Amd harms a class of stock, Amd must be approved by shares of that class itself as well as by overall majority of all shares entitled to vote. This is class voting. III. MERGERS [B, Inc. merges into A Corp.] OR CONSOLIDATIONS [A Corp. & B, Inc. form C Corp.] Requires:

(1) Board of director action (both Corps), & notice to shareholders. (2) Shareholder approval (generally both Corps). Majority of shares entitled to vote. (3) If approved, file articles of merger (or consolidation) w/ Secy of State. (4) REMEMBER DISSENTING SHAREHOLDER RIGHT OF APPRAISAL. (5) Effect of merger or consolidation: Surviving Company succeeds to all rights & liabilities of constituent. Successor Liability -- This rule makes sense b/c constituent Corp disappeared. So a creditor of that Corp can sue survivor. IV. TRANSFER OF ALL OR SUBSTANTIALLY ALL OF THE ASSETS NOT IN THE ORDINARY COURSE OF BIZ OR SHARE EXCHANGE (one company acquires all the stock of another) (1) Are these fundamental changes for transferring Corp? Yes. (2) Are these fundamental changes for buying Corp? No, so shareholders of buying Corp DO NOT VOTE ON THESE. Hypo-- S Corp. wants to sell all of its assets to B, Inc. or B, Inc. wants to buy all shares of S Corp. We Need: (1) Board of Director Action (both Corps), & notice to selling Corp=s shareholders. (2) Approval by transferring Corps shareholders. A. Number of shares of S Corp. that must approve sale? Majority of shares entitled to vote. B. Number of shares of B, Inc. that must approve sale? NONE. THEY DON'T VOTE, B/c IT'S NOT A FUNDAMENTAL CHANGE FOR BUYING CORP. (3) Are there dissenting shareholders rights of appraisal? Yes, for shareholders of transferring Corp only. (4) File articles of exchange w/ Secy of State in share exchange. Usually, no filing in transfer of assets. (5) Generally, acquiring company isnt liable for debts of acquired company unless deal says otherwise or unless company purchasing assets is merely a continuation of selling Corp. This makes sense, b/c Corp that sold its assets still exists, so a creditor can still sue it. DO NOT expect successor liability, b/c Corp still exists, so creditor can sue it. V. DISSOLUTION (1) Voluntary A. Board of directors action & approval by a majority of shares entitled to vote. B. File articles of dissolution & give notice to creditors. (2) Involuntary (by court order)

A. Shareholder can petition b/c of: (1) director abuse, waste of assets, misconduct; or (2) director deadlock that harms company; or (3) shareholder deadlock & failure for at least 2 annual meetings to fill a vacant board position. Alternative to Dissolution: court might order Corp or majority shareholders to: buy-out petitioning shareholder. Especially likely in a close Corp. B. Creditor can petition b/c Corp is insolvent & creditor either has an unsatisfied judgment against Corp or Corp admits debt in writing. (3) After filing articles of voluntary dissolution, or after court order of involuntary dissolution, Corp stays in existence to wind up. Winding up: (a) gather all assets, (b) convert to cash, (c) pay creditors, & (d) distribute remainder to shareholders pro- rata by share unless there is a dissolution (or liquidation) preference. What's a Liquidation Preference? Works like a dividend preference; pay 1st. FACT PATTERN 6: FEDERAL SECURITIES LAW I. SECURITIES ARE INVESTMENTS. (1) Debt. Investor lends capital to Corp, to be repaid (usually w/ interest) as specified in agreement. Shes a creditor, not owner, of Corp. A. Secured by corporate assets bond B. Unsecured debenture. (2) Equity. Investor buys stock, & has ownership interest in Corp. This status carries various rights, e.g., to inspect records, bring derivative suits. Shes an owner, not a creditor, of Corp. II. RULE 10b-5CAIMED AT DECEITFUL BEHAVIOR Federal law prohibits fraud & misrepresentation (or nondisclosure) in connection w/ purchase or sale of any security (debt or equity). (1) Instrumentality of Interstate Commerce- (telephone, mail or if deal goes through national exchange) Just have to touch telephone, internet. (2) Type Transactions A. Misrepresentation of material info. B. Trading on inside info when duty to disclose exists (relationship of trust & confidence w/ shareholders of Corp). This means insiders cant trade on secrets. They must abstain or disclose so everybodys on same footing. C. Tipping (passing along material inside info for a wrongful purpose, ex telling Mom). (3) Materiality- Misrepresentation or omission must concern a material fact one that a reasonable investor

would consider important in making an investment decision. (4) Possible plaintiffs: A. SEC, B. Private action for damages by buyer or seller of securities Hypo: Widget Corp. issues a press release that Buffett has expressed an interest in acquiring a major block of its stock. Release fails to indicate that its Jimmy Buffett & not Warren Buffett who is interested. B/c of this press release, Duffy doesnt sell his Widget stock. Does Duffy have a 10b-5 cause of action? No, b/c he didnt buy or sell in reliance on this. (5) Possible D* any person (including entities). A. Company that issues a misleading press release. B. Buyer or seller of securities who misrepresents material info. C. Buyer or seller of securities who trades on material inside info (when theres a duty to abstain or disclose, which comes from relationship of trust & confidence w/ shareholders of Corp). D. Tipper or tippee. 1. L, a lawyer for X Co., learns that X Co. is planning to merge w/ Y Corp. She telephones her son-in-law Joe about this, & urges him to buy X Co. stock. Acting on tip, Joe buys the stock. Any violations of Rule 10b-5? L is a tipper b/c: (1) she passed inside info in breach of a duty to X Co., & (2) she benefitted. How did she benefit? -- Joe is a tippee b/c (1) he traded on tip & (2) knew or shouldve known that info was improperly passed. 2. D is a director of C Corp. While waiting for a concert to start, D tells her husband about a new, secret processing method that C Corp. has just developed. Bobbitt, whos sitting in next row, overhears conversation & buys C Corp. stock on a national exchange. Any violations of 10b-5? No. At worst, D was merely negligent, which isnt enough for 10b-5 liability. -- So D isnt a tipper. UNDER 10B-5, IF THERE IS NO TIPPER, THERE CANNOT BE A TIPPEE. (6) Scienter. D must have an intent to deceive, manipulate or defraud. Recklessness may suffice. (7) Reliance. Said to be a separate element, as in fraud, but is presumed in public misrepresentation & nondisclosure cases. III. SECTION 16BCAIMED AT SPECULATION BY DIRECTORS, OFFICERS, & TEN PERCENT SHAREHOLDERS. THIS IS STRICT LIABILITY! INTENT IS IRRELEVANT.

This federal law provides for recovery by Corp (so it could be a shareholder derivative suit) of profits gained by certain insiders from buying & selling company=s stock. Theory is that its bad for market confidence to have these insiders buying & selling their own Corp=s stock. (1) When does 16b apply? A. Reporting Corp C (i) listed on a national exchange or (ii) at least 500 shareholders & $10 mil in assets. B. Type D* (I) Director (either when she bought or sold) or (II) Officer (either when she bought or sold) or (III) Shareholder who owns more than 10 % of Corps stock (to be covered, she must own this much both when she bought & sold) C. Type Transaction. Buying & selling stock w/in a single 6-mo period (shortswing trading). Multiply $5 profit times 200 shares. Why 200? B/c thats largest number of shares she both bought & sold w/in 6 months.

(2) What Happens When 16b Applies? All profits from such short-swing trading are recoverable by Corp. If, within 6 months before or after any sale, there was a purchase at a lower price, there is a profit. Hypo-- D is a director of Acme, Inc., which is a reporting Corp. In 05, D bought 700 shares of Acme stock for $10 a share. In Jan 07, D sold 700 shares for $6. In March 07, D bought 200 Acme shares for $1 a share. What result? Doesnt seem like theres a profit but there is a $1k profit under 16B. Strict Liability, no defense. D owes Corp $1k. KEY TO 16B -- FOCUS ON THE SALE. HERE THE SALE WAS JAN 07, D SOLD AT $6. (1) --Did she buy at less than $6 w/in 6 months before sale in Jan 07? No (2) Did she buy at less than $6 w/in 6 months after the sale in January 2007?