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Definitions
Contracts
Types of Contracts
• Bilateral vs. unilateral
• Executed vs. executory
• Express vs. implied
• Output and requirements
“A binding agreement that courts will
enforce”
“A promise or a set of promises for the breach
of which the law gives a remedy, or the
performance of which the law in some way
recognizes a duty”
Bilateral vs. Unilateral
A bilateral contract is a promise for a
promise that involves each person giving a
promise.
A unilateral contract is a promise for an act.
This commonly occurs in reward situations,
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Example: Ann hires Jeff to look for her missing watch. Ann offers Jeff $10 for
his services, and he agrees. This is a bilateral contract because Ann has
promised to pay Jeff $10, and Jeff has promised to look for Ann’s missing
Executed vs. Executory
watch (even if he does not find it).
An executed contract is one that has been
fully performed.

Example: Ann offers a $50 reward to anyone who finds and returns her
missing watch. Bob sees Ann’s reward poster on a telephone pole, and he An executory contract is a contract that has
locates Ann’s watch and returns it to her. Is Ann obligated to pay Bob the
reward?
not been fully performed and some terms
remain outstanding by one or both parties.

Express vs. Implied Output and Requirements

An express contract is a contractual In an output contract the seller agrees to sell
agreement based upon a written document to the buyer all of their production.
or oral communication.

An implied contract exists when the actions
and behaviors of two parties suggest that a
contractual agreement is in place between
the two parties even though the agreement is
not in written form, or communicated orally.
In a requirements contract the purchaser
promises to buy all of the materials that they
need from this specific supplier.
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Status of a Contract Elements of Valid Contract

A valid contract meets all requirements. 1. Offer,
A void contract is not enforceable against any 2. Acceptance,
of the contractual parties. 3. Consideration,
A voidable contract is one in which one of 4. Proper Form (Statute of Frauds),
the parties has the right to rescind (cancel)
5. Lawful Object, and
the contract without penalty.
6. Competent Parties (Legal Capacity to
An unenforceable contract is a contract that
Contract).
cannot be enforced by the courts.

Offer
In order for an offer to be valid, it must be
Offer A. Seriously intended,
B. Communicated, and
C. Definite in terms.

A. Seriously Intended
When determining the seriousness of an offer,
courts apply a “reasonable person”
standard.
Illusory promises or promises made in jest
(jokes) fail the reasonable person test and are
not enforceable offers.
C. Definite in Terms
The terms of the offer have to be specific
enough that it is clear what the offer is and
what the terms of the contract actually will be.
Generally, the time, subject matter and
price must be stated in the offer in order for
it to be definite in terms.
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B. Communicated
Offers may be communicated either through
written or spoken words or by the actions of
the offeror.
• A general offer is communicated to no-
one specific and could apply to anyone
who responds.
• A specific offer is communicated to a
specific individual.
Advertisements
Advertisements and price quotations are not
offers; instead, they are considered
“invitations to bid.”
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Revoking an Offer Exceptions to Revoking an Offer

Offers may generally be revoked by the
offeror before the offer is accepted.
However, there are some rules :
• The revocation becomes effective only
when it is received by the offeree.
• Even when the offeror has guaranteed
that the offer will be held open, the
offeror can revoke the offer before it is
accepted.
If offeree pays consideration to keep it open,
the offeror can’t revoke it. (Option contract)
An offer ends at the end of the time stated by
the offeror, or if the time is not stated, after a
reasonable amount of time has passed (again
reasonable person standard).

Offer Terminated Without

Acceptance
1. Rejection
2. Counteroffer Acceptance
3. Revocation of Offer
4. Death or Incompetence before Acceptance
5. Destruction of Subject Matter
6. Known Sale of Subject Matter

Acceptance
Unconditional. The offeree must agree to all
the offeror’s terms and conditions – the
offered terms or conditions cannot be
changed.
Communicated. The offeree must
communicate acceptance to the offeror in
some manner.
Acceptance May NOT be assigned to others
Written Acceptances
Mailbox Rule – an enforceable contract is
formed as soon as the offeree delivers the
acceptance to the mail.
Exception: If the offeror specifies that
acceptance must be received by the offeror
by a certain date, then the Mailbox Rule does
not apply.
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Manner of Acceptance
If the offer states a specific manner by which
acceptance must be made, then the
acceptance must be done in exactly the way
outlined by the offer.
When the offer is silent about the way in
which the offer may be accepted, the offeree
may accept in any way that they want.
Speed of Acceptance
A faster means of acceptance is allowed.
Exception: If the offer specifies a specific
method of delivery, then that, and only that
method can be used.
If a slower means of acceptance is used, it is
valid only when received by offeror.

Acceptance Through Silence
There are three situations in which silence can become
acceptance.
1. The offer indicated silence would constitute
acceptance AND the offeree intended their silence
to be acceptance.
2. The offeree has taken control of goods or services
and has control over them when they could have
(had the opportunity to) rejected the goods.
3. When there have been previous dealings between
the parties, or through custom, in which silence
was considered to be acceptance.
Consideration
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Example: On June 1, Ann mails a letter to Bob offering to rent Bob a boat for
$1,000 for his personal use for the month of July. Ann’s offer states that Bob
may accept the offer by signing Ann’s letter in the appropriate place and
returning it to Ann. Bob receives the letter on June 3, signs it, and mails it back
to Ann the same day.
On June 4, Ann calls Bob and revokes the rental offer, stating that she already
has found a renter. Bob tells Ann that he already has signed and mailed the
contract and that he wants to enforce the contract.
(a) Is Ann’s revocation effective?
(b) Would your answer to (a) change if Bob had faxed his acceptance to Ann
and she never received the fax?
Consideration
Consideration is what is given up by each
party in the contract.
Both parties must give up something (or be
required to do something that they currently
are not required to do) in order for a valid
contract to be formed.

Consideration Details
1. Must be legally sufficient – not financially
equal.
2. Not limited to money.
3. Past consideration is not legally sufficient.
4. Conditional promises may be included in
the consideration.
5. Pre-existing obligations are not legally
sufficient consideration.
Example: Ann agrees to pay Cam $5,000 if he will build Ann a new garage by
December 23. Cam agrees, but later discovers that he has insufficient staff to
complete the job on time. Cam demands an additional $1,000 to finish the job
on time, and Ann does not object to the extra payment. Cam finishes the job
on December 23, but Ann refuses to pay the extra $1,000. Is Ann contractually
obligated to pay Cam the extra $1,000?
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Consideration in Modification
When a contract term is changed, new
consideration must be provided in order for
the modified terms to be enforceable.
Contracts Without Consideration
Charitable Donation Pledges. The law looks favorably upon
charitable organizations. Therefore, all charitable pledges are
enforceable even if the charity did not provide any
consideration to the party giving the money.
Voluntary Agreement that does not need to be entered
into.
Promissory Estoppel Situations (an Equity Consideration).
When the party that did not provide consideration is harmed
by relying on the promise the party that did provide
consideration, courts sometimes will fashion an equitable
remedy for the injured party.
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Example: Joan plans to work during the summer to finance her next year’s
college tuition. Uncle Dan tells Joan “Take the summer off from school, and I
will pay your tuition next year.” Joan takes the summer off, but Uncle Dan
refuses to pay. Will Uncle Dan be required to pay Joan’s tuition for one year if
this matter is adjudicated?

Proper Form

Proper Form Contractual Terms

Generally, contracts do not need to be in Contractual terms must include:
writing, nor do they need to have a specific 1. Parties to the contract.
form or format. 2. The subject of the contract.
3. The primary terms and conditions such as
Statute of Frauds is the exception – these dates, timing, etc.
need to be in writing. 4. Description of the consideration.
5. The signature of the party against whom
the contract would be enforced.
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Statute of Frauds
1. Sale of goods for $500+
2. Realty contracts Lawful Object
3. Contracts that CANNOT be completed in
12 months
4. Assumption of debt of another person
5. Marriage contracts

Lawful Object Examples of Unlawful Content

Contract object must be lawful.
1. Illegal subject matter.
Licensing rule – if license needed, but does
not have, the contract is illegal
2. Covenants not to compete. These agreements
are enforceable as long as they are
reasonably needed to protect a business, they
are for a reasonable amount of time, and they
are reasonable as to distance.
3. Promise to do something required by law.
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Competent Parties
Three most common incompetent parties are
Competent Parties 1. Minors
2. Incapacitation due to drugs or alcohol
3. Insanity

Minors and Contracts Right of Minors to Disaffirm

Though not capable to enter into a valid Minors have the absolute right to disaffirm
contract, they can still enter into an contracts at any time while they are minors or
“attempted contract.” within a “reasonable” time after 18.

Right of Minors to Ratify
Upon reaching the age of majority (or shortly
afterwards), the minor has the option of
ratifying the contract.
When the individual who had entered into the
contract while they were a minor ratifies the
contract, he or she agrees to be bound by all
of the contract’s terms. It is not possible to
ratify only some of the contracts terms.
Liability of Minors Under Tort Law
Although minors have an absolute right to
disaffirm contracts, minors also are liable for
any civil wrongs (torts) they commit in their
courses of dealing.
This includes lying about their age.
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Right of Minors to Return Property
Minors who disaffirm contracts have the duty
to return the contracted property that they
possess or control at the time of their
disaffirmance.
It does not matter the condition of the
property; they will return the property and
get their money back.
When 14, Ann bought a new car. She kept it for two years and drove it 40,000
miles. At the end of year two, Ann returned the car to the dealer. May the
dealer deduct any money for vehicle wear and tear, or must he refund Ann’s
total purchase price?
What if the car had been in an accident and had been badly damaged?
What if at the time of the purchase Ann provided the dealer with false
identification indicating that she was an adult. Is the dealer required to refund
the total purchase price to Ann?
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Invalidation of Mutual Assent

Though this is not one of the specific
Invalidations of elements, the law requires that the agreement
to the terms of the contract be voluntary and
Mutual Assent willing. If the agreement is not voluntary and
willing, the agreement will be either
• Void, or
• Voidable.

Causes of Invalidation 1. Fraud

1. Fraud A. Actual Fraud
2. Innocent (or nonfraudulent) B. Constructive Fraud
misrepresentation C. Fraud in the Inducement and
3. Mistakes D. Fraud in the Execution
4. Duress
5. Undue influence
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1A. Actual Fraud 1B. Constructive Fraud

1. Material Misrepresentation or 1. Material Misrepresentation.
Concealment 2. Recklessness.
2. Scienter 3. Detrimental Reliance.
3. Detrimental Reliance 4. Damage.
4. Damage

1C. Fraud in the Inducement 1D. Fraud in the Execution

Occurs when the defrauded party knows that a Occurs when the defrauded party was not
contract was made, but the accused (culpable) even aware that a contract had been made.
party has intentionally misrepresented one or
more material contract terms in order to get the Contracts involving fraud in the execution are
other party to enter the contract. void as a matter of law.
The defrauded party may either:
• Rescind the contract, or
• Accept the contract and sue for damages.

2. Innocent Misrepresentation
A false representation of a material fact that is made
without knowledge of the falsity.
The injured party must prove:
1. They reasonably relied on the erroneous statements,
2. There was a material misrepresentation,
3. Must have sustained damage as a result of relying on
the erroneous statements.
The injured may also rescind the contract or sue for
damages.
Mutual and Unilateral Mistakes
A mutual mistakes (or bilateral mistakes) involves
materials facts that are made by both parties. A mutual
mistake makes the contract voidable by either party.
A unilateral mistake occurs when only one party makes a
material mistake. The party who made the mistake may
disaffirm the contract only if the other party
A. caused the mistake, or
B. knew, or should have known, about the mistake.
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3. Mistakes
Generally, mistakes that are made in the
contract have no effect on contracts (basis of
contract law: “a deal is a deal; either perform
or pay damages”) and the contract is valid as
written.
A material mistake can cause the contract to
be voidable.
4. Duress
The use of threats and/or violence to induce
(cause) someone to be an unwilling party
to a contract.
Duress takes the choice of free will away from
the other party and leaves the other party
with no reasonable alternative other than to
accept the terms of the contract that are
being presented to them.
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Types of Duress Physical and Mental Duress

There are four kinds of duress: A contract made under physical force is
1. The threat of physical violence or harm to the void.
individual or to their family or property,
2. The threat of criminal prosecution or threat of a
lawsuit if the threat is made with the knowledge that A contract made under mental duress is
there is no basis for the lawsuit or prosecution,
3. The threat of personal or family social disgrace and voidable.
extreme embarrassment, and
4. The threat of economic devastation or loss if the
person under duress can show that the actions of the
other party will cause the economic devastation.

5. Undue Influence
Involves unfair use of a position of trust,
confidence or affection to compel an
individual to be a party to a contract.
Parol Evidence Rule

Contracts formed under these conditions are

voidable.
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Parol Evidence Rule After the Contract Items

Generally a contract is a contract – Events that occur after the contract was
“four-corners rule”. signed (this is called subsequent evidence)
will be admitted into court to clarify or
interpret the contract.
Evidence of what was before, or during, the In addition, subsequent agreements that
signing is not admissible. change the original written contract,
sometimes called contractual amendments,
are valid as long as they are valid contractual
arrangements.

Example: During negotiations, the discussed price was $100 per unit.
However, in the contract the price $110 was written and this version of the
contract was signed by both parties. If, after the contract was signed, an
Exceptions to Parol Evidence Rule
invoice was issued for $100 and was paid for $100 per unit, this evidence can
be introduced to show that the contract was really supposed to be $100. In these situations, prior or contemporaneous
This is because if the contract was supposed to be for $110, presumably the evidence will be allowed in court:
selling party would not have issued an invoice for $100 per unit. But, the fact
that they did issue an invoice for $100 shows that they believed that the 1. Fraud.
contract was for $100 per unit, as per the prior negotiations.
2. A partially written contract.
3. A clerical, or typographical error.
4. Ambiguity of Language.
5. The lack of capacity of one of the parties.
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Third Party Beneficiary Contracts

For a third party to have rights under the
contract, they must be an intended beneficiary.
Third Party 1. Donee Beneficiaries are individuals who will
Beneficiary Contracts receive the proceeds of a contract as a gift.
2. Creditor Beneficiaries are individuals who
receive the benefits of a contract as
compensation for amounts owed to them
by one of the contractual parties.

Incidental Beneficiaries
Incidental beneficiaries have no rights to
claim for damages under the contract.
Incidental beneficiaries are individuals who
Discharge of Contracts
would benefit from a contract, but are not
parties to the contract themselves and were
not specifically intended to be the
beneficiary.
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Discharge of Contracts 1. Performance

Contracts may be discharged by: Complete Performance
1. Performance Substantial Performance
2. Breach
3. Agreement
4. Operation of Law

2. Breach Remedies for Breach of Contract

When one party breaches a material term of the Must seek damages within the Statute of
contract, the other party is released from their Limitations
contractual duties.
Other items similar to breach that you need to know:
1. Compensatory Damages
• Anticipatory Repudiation (Anticipatory Breach). 2. Punitive Damages
• Prevention of Performance. 3. Specific Performance
• A material, unauthorized alteration of a written 4. Injunction
contract by one of the parties of the contract
discharges the entire contract.

Compensatory Damages
Compensate for certain and foreseeable
damages incurred by the breach
Liquidated damages are penalties for
breaching contract.
Accord and Satisfaction
The parties agree to change a contractual
term by substituting a new contractual term
for an existing one (this is the accord). The
performance of the new term is the
satisfaction.
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3. Agreement
Release.
Waiver.
Mutual Recission.
Novation
This is the voluntary replacement of one of
the parties with a new party. All three
parties must agree to the replacement of the
one of the parties in order for this to be valid.
Except for the change in one of the parties, all
other terms of the contract remain the same.
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Substituted Contract 4. By Operation of Law

The parties agree on a new contract that
replaces an existing contract.
Impossibility
Frustration of Purpose
Subsequent Illegality
Commercial Impractability
Bankruptcy
Expiry of Statute of Limitations

Assigning Rights
A party is generally able to assign its rights to
receive under a contract to someone else.
Assigning Rights and
The assigning of rights may be done only if it
Delegating Duties does not materially increase the other
party’s risks or obligations.
When rights under a contract are assigned,
the assignee receives all of the rights under
the contract from the assignor.

Enforcing Assigned Rights
The recipient of the rights (called the
assignee) will be able to enforce their rights
against the assignor until they have
received what they are supposed to have
received.
This means that the assignor will be liable to
the assignee until the assignee receives the
benefits of the contract.
Warranties Given
by Compensated Assignor
1. The assignor will not do anything to
destroy or impair the assigned right,
2. The right under the contract actually exists,
3. The right is not subject to any defense or
counterclaim by the obligor that would
prevent it from being paid, and
4. Any token or writing that the assignor
delivers as evidence of the assigned right is
genuine.
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How to Assign Rights
There does not need to be any transfer of money
for this to be done and the assignment of
rights does not need to be in writing.
Three that can’t be assigned:
1. Insurance Contracts
2. Personal services or confidential matter
3. Contracts that specifically prohibit the
assigning of rights to receive something other
than money (which can always be assigned).
Delegating Duties Under Contracts
May usually be done.
But, the delegation of duties does not
release the delegator from the obligation
to perform. If the party to whom the duty
is delegated does not perform, then the
delegator will be required to perform.
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Secured Transactions Intro

• An agreement by which the secured party
Secured Transactions obtains a security interest in the personalty
of the debtor.

Five Components of a
Property Used as Collateral
Secured Transaction
1. Debtor Usually, the collateral property is something
2. Secured creditor that is obvious and tangible such as
equipment or a car.
3. Collateral
4. Security agreement
5. Security interest • After-acquired-property.

• Security interest in proceeds.

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A PMSI Creditor Becoming a PMSI Creditor

• Purchase money security interest creditor
• A specific type of creditor that has more
rights to the collateral property than a
creditor that is not a PMSI.
Two situations in which the creditor becomes
a PMSI creditor are:
1. The debtor borrows the money from the
creditor and uses that money to purchase
the collateral property from another party,
or
2. The debtor obtains the collateral property
directly from the creditor, with the promise
of later payment.

Example: John wants to purchase a new car, but he has insufficient

cash to buy the car outright. He goes to First National Bank and
obtains a new car loan for $14,000.
First National Bank is a PMSI creditor.

Example: Hank wants to take out a loan from First National Bank to do
Unsecured and Attached
some home improvements. He has fully paid for a car worth $18,000,
and he pledges this car as collateral for the home improvement loan. Creditors
There is no PMSI creditor.

Example: Hank purchased a new computer on account from Circuit

City, a local department store. Hank will make 24 monthly payments for
the computer.
Circuit City is a PMSI creditor.
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Levels of Creditor Protection Unsecured Creditor

Three classifications of creditors based on • An unsecured creditor has an interest in the
their claim to the collateral property: collateral property, but it is a very weak
1. Unsecured, one.
2. Attached, and • The unsecured creditor will lose the
collateral property to any creditor who is
3. Perfected.
either attached or perfected.

Attached Creditor Three Requirements for Attachment

• An attached creditor can enforce their
claim against the debtor – make them sell
the property.
• But, other creditors with a better claim will
have priority.
All three must exist.
1) There must be a consensual security agreement
(usually must be written) between the debtor and
creditor that creates a security interest.
2) The creditor must give value to the debtor.
3) The debtor must have rights in the collateral
property.
• Normally, the debtor cannot have rights in the
property until they actually have possession of it.
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Obligations of Creditor to Debtor A Pledge – An Oral Agreement

The secured creditor has obligations to the • An oral agreement only is sufficient in the
debtor while the security agreement is in place.
They include: case of pledges.
1. Filing or sending the debtor a termination • A pledge is a situations in which the
statement when the debt is paid. creditor actually holds, or has possession
2. Maintaining the collateral of the debtor of the debtor’s collateral.
separate from any other party’s collateral.
3. Confirming the unpaid amount of the debt
when the debtor requests.
4. Using reasonable care to preserve any
collateral in the secured party’s possession.

Example: Charlie needed cash, so he pawned his saxophone at Sam’s Pawn

Shop for $200. Charlie orally agreed to repay $210 in 60 days in exchange for
the return of his saxophone, and Sam agreed. Has attachment occurred?
Yes. Even though there is no written agreement, attachment has
occurred since Charlie’s Pawn Shop has physical possession of
the saxophone. Perfected Creditor
Example: On January 1, Dan borrowed $500 from Third National Bank to
purchase a new cash register for his store. He signed a promissory note and a
security agreement with the bank on January 1. On January 20, Dan bought
the cash register. When did attachment occur?
Attachment occurred on January 20, since Dan
did not obtain rights in the collateral until January 20.

Perfected Creditor
• A perfected creditor is protected not only
against the debtor, but also against the
claims on the property by other
creditors who are not perfected.
Using a Financing Statement
A financing statement is constructive notice to
third parties that a security interest exists in
collateral.
A valid financing statement has three elements:
1. The names and addresses of the debtor and
creditor,
2. The debtor’s signature, and
3. A general description of the collateral
property.
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Three Ways to Perfect a Claim
1. By taking possession of the collateral
property WITH the debtor’s agreement.
2. By publicly filing a financing statement.
3. By attachment, in some situations.
Perfection through Attachment
• PMSI creditors in consumer goods are
perfected automatically once attachment
has occurred.
• This means that they are not required to
file a financing statement and do not need
to take possession of the collateral in order
to perfect their interest if the sale is made
to a consumer.
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Effect of Perfection by Attachment Moving Collateral to Another State

• Perfection by attachment protects the PMSI • The perfection that was achieved in the
creditor against all subsequent creditors. first state remains intact in the second state
• Does NOT protect the PMSI creditor who for four months after the collateral is
perfected by attachment only from an moved.
individual who purchases the property
from the debtor without notice of the
security interest.

Who Wins?
Unsecured Creditor vs. Purchaser
Priority of Parties Attached Creditors vs. Purchaser
Perfected Creditors vs. Purchaser
Secured Creditor vs. Unsecured Creditors
Secured Creditors vs. Other Secured Creditors

Who is a Purchaser
A purchaser can occur either:
1. In the ordinary course of business (from a
merchant), or
2. Not in the ordinary course of business
(from a non-merchant).
Attached Creditor vs. Purchaser
• Unperfected creditors will lose to bona fide
purchasers who buy collateral without notice
of the security interest if the purchaser is a
buyer in the ordinary course of business.
• Unperfected creditors will lose to bona fide
purchasers who buy collateral even if they
have notice of the security interest if the
purchaser is a buyer in the ordinary course of
business.
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Unsecured Creditor vs. Purchaser
• The purchaser of unsecured collateral will
win in competition with an unsecured
creditor.
Exceptions
The purchaser will lose the purchased “collateral”
to the unperfected creditor if the purchaser has
knowledge that the seller did not legally own the
goods that they sold.
The unperfected creditor will win if the purchaser
is NOT a buyer in the ordinary course of business
unless the purchaser can prove three facts:
1. They gave value to the seller, and
2. They did not know about the security interest,
and
3. They took delivery.

Perfected vs. Purchaser
• Perfected creditors prevail over purchasers
of collateral in most instances.
• The main exception is to a consumer in the
ordinary course of business.
Secured vs. Unsecured Creditor
• Secured creditor wins.
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Perfected vs. Purchaser COCB
• The most common instance of the
purchaser winning is if the purchaser is a
COCB. The COCB (from a merchant) will
win unless he or she knew that the items
in questions should never have been sold.
• The purchaser will also win when the
purchase is made without any notice of a
security interest.
Secured vs. Secured
• Perfected wins against attached.
• Competing attached – whoever attached
first.
• Competing perfected – GENERALLY, First to
file, or first to perfect wins.
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Example: Martino Music Shop enters into a loan agreement with First National
Bank. First National agrees to lend Martino $20,000, secured by Martino’s
store equipment. First National files a financing statement, but no funds are
Exceptions for Perfected
sent yet to Martino.
PMSI Creditors have the opportunity to perfect in
Nine days later, Martino enters into a loan agreement with Second National
Bank, and Second National immediately gives Martino $15,000, also secured the goods that their loan “gave rise to”
by Martino’s current store equipment. Second National immediately files a
financing statement.
One week after Martino obtains the loan from Second National, First National
Exception 1: PMSI Creditor in INVENTORY Collateral
sends Martino the $20,000 according to the loan contract. If Martino defaults Exception 2: PMSI Creditor in NON-inventory
on both loans, which creditor has priority? Is there a PMSI creditor in this
scenario?
Collateral
Solution: First National Bank has priority because it filed its
financing statement before Second National Bank.

1. Inventory Collateral 2. Noninventory Collateral

A PMSI creditor in inventory collateral must
do two things before the debtor takes
possession of the inventory collateral:
1. File a Financing Statement, and
2. Give written notice of his security interest
to prior perfected creditors.
If a PMSI creditor files a security agreement
within 20 days of the date on which the
debtor takes possession of the property that
is acting as the collateral, the creditor’s
interest is perfected and it will be considered
to have been perfected first.
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Example: On May 1, Vito Manufacturing Company takes out a loan from First
National Bank, securitized by Vito’s existing and future business equipment.
First National files a financing statement (including an after-acquired property
clause stating that it takes in an interest in business equipment that Vito will
purchase in the future) on May 2.
On June 1, Vito purchases a new cash register on credit from Ace Supply
Company, and Ace retains a security interest in the cash register. Ace files a Remedies for
Secured Creditors
financing statement on June 9.
a) If Vito defaults on both agreements, which creditor will have priority?
b) Would your answer change if Ace had filed on June 22?
a): Even though Ace was the second creditor to perfect, Ace has priority
because it is a PMSI creditor in equipment, and Ace filed within the 20-day
statutory period.
b): If Ace had filed on June 22, its interest would be subordinate to First
National Bank’s interest because Ace exceeded the 20-day statutory window
within which to file.

Remedies for Secured Creditors 1. Repossession and Auction

The creditor can choose from two alternatives: 1. Peaceful repossession
1) Repossession and auction sale of the 2. Sale or redemption
collateral and/or • Creditor receives money for costs of holding
2) Adjudication. and selling
Note that the creditor is not required to proceed • Creditor receives money for amount of debt
initially against the collateral. The creditor can • Other junior claims and to debtor if anything
choose to go to court (adjudication) immediately left
if that approach is most appropriate. 3. Debtor has liability for deficiency
 6/19/2017

2. Adjudication
• The creditor can sue the debtor for breach
of contract. Lien Creditors

Lien Creditors 1. Consensual Liens

• A type of secured creditor. • Liens that are made with the consent of
the debtor and are usually included in the
original contract itself.
• A lien is
•
• “an encumbrance imposed on property to
force payment of a debt; if the debt
remains unpaid, the property (collateral)
can be sold to satisfy the debt (lien).”
 6/19/2017

2. Statutory & Common Law Liens

• A statutory lien is a lien that is created by an
operation of law, and common law liens generally
allow creditors to keep possession of the property
of the debtor until the debt is paid. Legal Remedies for
1) A mechanic’s lien – in real property.
2) An artisan’s lien – in personal property.
Unsecured Creditors
3) A bailee’s lien – in property entrusted to the bailee.
4) A landlord’s or innkeeper’s lien –can secure
payment by taking a possessory lien on the
tenant’s property.
5) A tax lien – obtained by the government to secure
payment of taxes.

Remedies for Unsecured Creditors 1. Writ of Attachment

Legal (court based) options are: • The debtor’s property is seized to secure
1. Writ of Attachment payment.
2. Garnishment
3. Execution

2. Garnishment
• The creditor garnishes an asset owned by
the debtor and will apply the garnished
asset to the amount owed by the debtor to
the creditor.
Fraudulent Conveyances of Property
A fraudulent transfer is a transfer that is
made:
1. With the intent to delay, hinder or defraud
creditors.
2. Without fair consideration received by a
person who is or will soon be insolvent.
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3. Execution
• The creditor obtains a judgment and
enforces it by execution, in which the
debtor’s nonexempt property is seized and
sold to satisfy the judgment.
Indications of Fraudulent Conveyance
1. The debtor maintains possession of the
property after the transfer,
2. The conveyance (transfer) is made in
secret, or
3. The debtor maintains an equity interest
in the property after the conveyance.

Other Collection Options
Other ways in which payment may be agreed
upon between the debtor and creditor and
the debt settled without the forced sale of
the debtor’s property.
1. Assignment for Benefit of Creditors
2. Composition or Extension Agreements
3. Equity Receivership
2. Composition or Extension Agreements
• Composition – the creditors agree to
accept immediate and/or partial payment
in full satisfaction of the debt.
• Extension – the debtor will pay the entire
amount of the debt that is owed, but over
a longer period of time.
• Creditors do not need to agree to these.
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1. Assignment for Benefit of Creditors
• The debtor transfers (assigns) the rights in his
or her nonexempt property to another person,
who will liquidate the assets and distribute the
proceeds.
• Generally, creditors do not need to agree to
this arrangement in order for it to take place.
• The debtor is usually not discharged from any
remaining debts after the liquidation of the
assets.
Result of Composition or Extension
• The debtor:
• retains all property that is not provided for
in the agreement and is
• discharged from any remaining portions of
debts that are repaid under the agreement.
 6/19/2017

3. Equity Receivership
• A court supervised liquidation or
reorganization in which the assets of the Federal Bankruptcy Law
debtor are sold and distributed.

• The remaining debts of the debtor are not

discharged.

Federal Bankruptcy Law Who Can Go Bankrupt?

• Emphasizes the equality of treatment • Either be a person (which includes
among creditors within the same class.
• Chapter 7 – Straight Bankruptcy or
businesses) or a municipality.
Liquidation
• Chapter 9 – Adjustment of Debts of a
Municipality (City)
• Chapter 11 – Reorganizations
• Chapter 12 – Family Farms and Family Fishers
• Chapter 13 – Adjustment of Debts of an
Individual with Regular Income
 6/19/2017

Chapter 7 – Straight Liquidation

• The majority of bankruptcies are
Chapter 7 Bankruptcy commenced under Chapter 7.
• The individual debtor is discharged from
almost all remaining debts.
• Corporations and partnerships are
liquidated rather than discharged of their
debts.

Eligibility for Chapter 7 Chapter 7 Means Test

• Any person can be considered a debtor • The means test essentially determines
under Chapter 7 except for: whether an individual really needs
• Railroads protection under the Bankruptcy laws.
• Domestic insurance companies
• Banks and other specified lending
institutions (including savings and loan
institutions)
 6/19/2017

The Means Test Calculation 5 Years of Income

Monthly Income • The Net Monthly Income is multiplied by
Minus Food, clothing and other items 60.
Minus Housing and utilities
Minus Transportation
Minus Other misc. expenses allowed by law
Equals Net Monthly Income

If Net Monthly Income … Then

Means Test 5 Years DELETE
* 60 is … Credit Counseling Service
More than $11,725 Chapter 7 NOT Allowed
($195.41 / month)
• Additionally, within 180 days of the filing of
Chapter 7, the debtor must receive a
Between $7,025 and Chapter 7 NOT be allowed IF this amount
$11,725 (net monthly income * 60) is more than
briefing from an approved, nonprofit
25% of the amount of unsecured debt of budget and credit counseling service.
the debtor. • This requirement may be waived if the
It will be allowed if the net income figure is trustee or bankruptcy administrator
less than 25% of the unsecured debts.
determines that such a service is not able
Less than $7,025 (Net Be allowed. to provide adequate service in the
Monthly Income is less
than $117.08)
situation.
 6/19/2017

Example 1: The debtor owes $50,000 in unsecured debts and has a net
monthly income of $205.
The net monthly income multiplied by 60 is equal to $12,300 so this debtor will
not be allowed to file the Chapter 7 bankruptcy. However, they would be
allowed to convert to a Chapter 13 filing.

Example 2: The debtor owes $50,000 in unsecured debts and has a net Chapters 11 and 13
Bankruptcy
monthly income of $125. The net monthly income multiplied by 60 is equal to
$7,500.
Since this income amount of $7,500 is less than 25% of the unsecured debt,
this debtor will be allowed to file the Chapter 7 bankruptcy.

Example 3: The debtor owes $25,000 in unsecured debts and has a net
monthly income of $125. The net monthly income multiplied by 60 is equal to
$7,500.
Since this income amount of $7,500 is more than 25% of the unsecured debt,
this debtor will not be allowed to file the Chapter 7 bankruptcy.

Chapter 11 - Reorganization The Reorganization Plan

• Designed primarily for businesses, but
can be used by individuals in certain
instances.
• The goal is to restructure a business’
finances so that it can continue to operate,
pay its creditors and generate a return for
investors without liquidating the business
itself.
• The reorganization is guided by the
reorganization plan that is developed by the
company and its creditors.
• The debtor must file a plan within 120 days
from the filing of the bankruptcy petition and
has the right to obtain creditor approval to
their plan for 180 days.
• If a plan has not been approved after 180
days, any creditor may submit a
reorganization plan.

Confirming and Approving the Plan
Two steps must happen for the reorganization
plan to become valid.
1. The bankruptcy court must confirm the
reorganization plan that is set up.
2. Prior to the court’s confirmation, however,
the plan must be approved by at least
one class of creditors.
Chapter 13 – Adjustment of Debts
• Chapter 13 enables individual debtors to
plan for the repayment of creditors over an
extended time period.
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Chapter 11 Administration
• The court is required to appoint a credit
committee that will be made up of
unsecured creditors.
• A trustee may be appointed in cases in
which there is fraud, dishonesty or gross
mismanagement by the bankrupt person.
Chapter 13 Eligibility
Chapter 13 is limited to individuals with:
1. Regular income,
2. Less than $336,900 in unsecured debts,
and
3. Less than $1,010,650 in secured debts.
 6/19/2017

Commencement of Bankruptcy
• Can by
Commencing 1) Voluntary
Bankruptcy 2) Involuntary

1. Voluntary Bankruptcy 2. Involuntary Bankruptcy

• The debtor can commence a voluntary case • Involuntary bankruptcy proceedings can be
simply by filing a petition with the bankruptcy commenced against any person under
court. Chapter 7 or 11, except for farmers,
• The filing of the petition constitutes an order for churches, schools and charities.
relief in a voluntary and uncontroverted
(uncontested) bankruptcy.
The debtor does not need to be insolvent in order to
file for bankruptcy voluntarily, but rather, only need
to have debts.

Involuntary Requirements
• If the debtor has 12 or more creditors 3 or
more creditors must sign the petition and
they must in total be owed at least
$14,425 in unsecured debt.
• If the debtor has less than 12 creditors, only
1 creditor needs to sign the involuntary
petition, as long as they are owed at least
$14,425 in unsecured amounts.
Unsuccessful Involuntary Filing
• If an involuntary filing is dismissed, the
defendant may claim court costs, attorney
fees, compensatory and punitive damages.
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Effect of Involuntary Filing
• The business or person can continue to operate until
an order for relief is filed.
• If the debtor responds in a timely manner, the court
will issue the order for relief only if they find that:
• The debtor is generally not paying their debts as they
become due, or
• Within 120 days of filing, a custodian was appointed or
took possession of the debtor’s property.
• If the debtor does not respond in a timely manner,
the court will enter an order for relief under the chapter
that the involuntary filing was made.
Filing Joint Bankruptcy
• In a joint bankruptcy, the court will
consolidate both the husband’s and wife’s
estates when determining the repayment
terms to creditors.

The Bankruptcy
Process
Administrative Duties of Trustee
• Within not less than 10, or more than 30 days, the
court calls a Meeting of Creditors with the trustee
presiding over this meeting. At this meeting:
1. The debtor must appear and submit to
examination under oath,
2. A creditor trustee or examiner can question the
debtor to determine if assets have been improperly
concealed or disposed of, and
3. The debtor’s acts, conduct, property or anything
else impacting the case can be examined.
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Role of the Trustee
• A trustee is appointed by the courts or
elected at the creditor’s meeting to be the
representative of the bankruptcy estate.
• The trustee is charged with the
administration of the estate and can sue
and be sued on behalf of the bankruptcy
estate.
Debtor’s Duties
• When debtor receives the order of relief from the
court, they must:
1. File a list of creditors, schedule of assets and
liabilities, and a statement of financial affairs
(including tax returns and payroll information).
2. Send notice to all creditors of the filing for
bankruptcy.
3. Cooperate with the trustee.
4. Surrender all property of the estate to the trustee.
5. Attend the discharge hearing.
 6/19/2017

What the Order for Relief (Stay) Does Duration of the Stay
The fundamental debtor protection is the automatic • The stay will remain until the earliest event
stay (order for relief). This legally halts all collection of either:
efforts, harassment, and all foreclosures or other
legal proceedings against the debtor. 1. The closure or dismissal of the case, or
2. Granting or denial of a discharge.
The rights of creditors are also protected because
the stay helps to prevent actions that would benefit
one creditor only.

Using Property During the Stay

• Upon notice to interested parties, the
trustee can use, sell or lease property of
the estate.
Creditors and Their Claims

Creditors and Their Claims
• Within 90 days of the creditor meeting,
creditors must make their claims against
the debtor known to the trustee.
• A creditor presents its claim for cash by
filing a proof of claim.
• An equity security holder files a proof of
interest.
Middlemen or Involuntary Gap
Creditors
• These are persons who have claims that
arose
1. In the ordinary course of business,
2. After the filing of an involuntary petition,
3. But before the order for relief.
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Claims of Co-Debtors,
Sureties and Guarantors
• Generally, these parties can only claim for
amounts they have actually paid on behalf
of the bankrupt party.
Accepting Claims Against Debtor
1. Claims must be adequately documented.
2. The bankruptcy court must decide about disputed claims.
3. Claims must be presented in a monetary amount.
4. The bankruptcy court may penalize and disallow portions of
claims if the court believes that a creditor did not negotiate a
pre-bankruptcy debt repayment plan in good faith.
5. The bankruptcy court may disallow entire claims from creditors
who have withheld assets that should be included in the
bankruptcy estate.
6. Claims from co-debtors, sureties, or guarantors must be
disallowed if the related creditor’s claim is disallowed.
 6/19/2017

Allowed Administrative Expenses

1. The actual, necessary costs and expenses of preserving the estate,
including wages, salaries, or commissions for services rendered after the

2.
commencement of the case,
Most taxes incurred by the estate and any associated fines or penalties, Priority of Claims
3. Compensation and reimbursement awarded to trustees and examiners
hired by the trustee and the lawyer of the debtor,
4. Actual or necessary expenses paid by the creditor in filing involuntarily,
5. Actual or necessary expenses paid by the creditor in recovering property
transferred or concealed by the debtor,
6. Reasonable fees for professional services rendered by an attorney or an
accountant of these entities in the above two situations [4 and 5], and
7. Witness fees and mileage.

Priority of Claims Priority of Claims

• All of the claims in a certain category must 1. Secured Claims, becomes unsecured for
be paid before any claims in the next any amounts not covered by collateral
category may be paid.
2. Alimony, maintenance or child support
• If there are not enough funds to pay all of a 3. Allowed administrative expenses
category, all holders of claims in that 4. Middlemen – Involuntary gap creditors
category receive a pro rata portion of their 5. Allowed unsecured claims for wages,
claim based on the amount that is available salaries and commissions to the extent of
to be paid.
11,725 for each employee
 6/19/2017

Priority of Claims Priority of Claims

6. Certain unsecured contributions to
employee benefit plans
7. Farmers and Fishers against debtors who
operate grain or fish storage facilities up to
$5,400 per claim
8. Allowed unsecured claims up to $2,600 for
money deposited with debtor for purchase
or rental of property for individual or
family use.
9. Allowed unsecured claims of a
governmental unit (whether federal, state
or local) for certain taxes – such as
income, property, withholding, excise and
employment taxes and customs duties.
10. Liability related to the operation of a
motor vehicle under the influence of
drugs or alcohol.

Priority NEXT and DELETE

• 11. General unsecured creditors. Payments are
prioritized as follows:
a. Unsecured creditors who filed their claim in a
timely manner.
Liquidation of Assets and
b. Unsecured creditor who did not file their claims in
a timely manner.
Discharge of Debts
c. Fines and penalties that existed prior to the filing
of bankruptcy that are not related to an actual
monetary loss by the creditor.
d. Any interest accrued from the date of the
bankruptcy filing on any claim that is paid out.

Debtor’s Benefits of Bankruptcy
• Usually, assets are liquidated, debts are
paid and any remaining debts are then
discharged.
There are two large exceptions to this
description.
1. Not all of the assets of the debtor are
liquidated during bankruptcy and
2. Not all of the remaining debts are
discharged.
Federal List of Exempted Property
• Up to $20,200 of real or personal property of the
residence used by the debtor or their dependents
• Up to $1,075 (plus any unused amount from the
real or personal property listed above) in any
property
• Up to $3,225 in a motor vehicle, up to $1,350 of
jewelry and up to $2,025 in tools of trade
• Household goods, furnishings, clothing, etc., for
household use of the debtor but not too exceed
$525 for any one item
• Unmatured life insurance
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Debtor’s Assets NOT Liquidated
The debtor will be able to retain some
property in order to allow a “fresh start” after
the bankruptcy.
The debtor must file a list of property that he
or she claims as exempt. Unless objected to,
the items on this list will be exempted.
Federal List of Exempted Property
• Up to $5,475 in education savings accounts (that
meet IRS requirements)
• Up to $10,775 in unaccrued dividend or interest
under unmatured life insurance,
• Professionally prescribed health aids, and
• Right to receive social security, unemployment and
other benefits.
 6/19/2017

Exceptions to the Federal List Debts NOT Discharged

Exempt property may be seized for the
payment of:
1. Debt for taxes not discharged in
bankruptcy,
2. Debt for alimony, maintenance or child
support, and
3. Valid liens not voided by the trustee.
1. Tax debts
2. Debt from gaining money or credit under
false pretenses
3. Debts not included in the required
schedule
4. Debts for fraud, embezzlement or larceny
5. Debts to a spouse, former spouse or child
for alimony, maintenance or child support

Debts NOT Discharged Debts NOT Discharged

6. Debts for luxury goods owed to single
creditor in excess of $1,225
7. Luxury good charges in excess of $550 that
were made within 90 prior to filing
8. Cash advances in excess of $825 received
within 70 days prior to filing
9. Debts for driving while intoxicated or under
the influence (DUI) of drugs or alcohol
10. Car loans entered into within 3 years of
bankruptcy
11. Domestic support payments,
12. Homeowners’ association fees,
13. Pension and profit sharing debts,
14. Debts for willful or malicious injury, and
15. Debts to the government (taxes, fines,
penalties, educational loans, etc.).

Bankruptcy Decision for Individual
For Chapter 7, a court must grant a discharge if the
debtor is an individual, unless the debtor has done
any of these within 1 year of filing the petition:
1. Concealed, falsified or failed to maintain
relevant records, or
2. Knowingly and fraudulently made a false oath,
presented a false claim, withheld information or
attempted to bribe someone, or
3. Failed to explain a loss of assets.
The Bankruptcy Estate
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Waiving Discharge of Debts
• A debtor can waive this discharge of debts by
signing a reaffirmation agreement.
• The debtor must be informed of what the
agreement signifies, and if it is filed, the
courts must accept the reaffirmation
agreement.
• However, the reaffirmation agreement can be
rescinded before the discharge, or within
60 days of filing the agreement, whichever
is later.
Property in Bankruptcy Estate
The property of the estate consists of the debtor’s assets
administered in bankruptcy. The estate consists of:
1. All legal and equitable interests in property
2. Proceeds, products, offsprings, rents and profits of estate
property
3. Property interests acquired after the bankruptcy commenced
4. Property interests acquired within 180 days of commencement
by bequest, devise, or inheritance, as the result of a property
settlement with a spouse, or as a beneficiary of life insurance
5. Gifts received by the debtor 180 days after filing
6. Interest received within 180 days of filing

Property NOT in the Estate
Property that does not become part of the
estate includes:
1. Earnings of the debtor after the
commencement of the proceedings (this
includes alimony and social security), and
2. Property held in trust by the debtor.
Voiding PREFERENTIAL Transfers
A preferential transfer is a transfer that put
one creditor in a better position than they
would have been if they had received a
distribution through bankruptcy.
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Trustee’s Power over Property
The trustee has legal rights to ensure that the property of
the estate is complete for the bankruptcy process. These
rights include:
1. The power to require any persons holding the debtor’s
property at the time the petition is filed to deliver
control of the property to the trustee.
2. The power to void activity that is judged preferential or
fraudulent and return the resulting assets to the estate.
3. The power to obtain a judicial lien on the debtor’s
property and thus establish priority over an
unperfected secured party as to the debtor’s property.
4. The power to avoid certain statutory liens such as a
landlord’s lien.
Preferential Transfers
• A transfer is considered to be preferential
and may be voided by the trustee if all of
the following tests are met:
1. The transfer is at least $5,850,
2. The transfer is for the benefit of a creditor.
3. It is made as a payment for or to secure
(collateral given to the creditor) an
antecedent debt. An antecedent debt is
one existed before the transfer was made.
 6/19/2017

Preferential Transfers What CANNOT Be Voided

4. The creditor who received the transfer got
more than he or she would have through
bankruptcy proceedings.
5. The debtor was insolvent when the
payment (transfer) was made.
6. The transfer was made:
• Within 90 days of the filing date, OR
• Between 90 days and 1 year prior to filing if
the creditor was an insider.
A trustee cannot void the following transfers:
1. Contemporaneous exchanges made for new
value given to the debtor.
2. Payment in the ordinary course of business
made not more than 45 days after incurred.
3. Child support and alimony payments.
4. Payments made on consumer debt if less than
$5,475 and occurring within 90 days of filing.

Voiding FRAUDULENT Transfers

The sale of an asset or the incurrence of a liability
within the 2 years prior to the bankruptcy filing that:
• Was done with the intent to cause damages to a Securities Regulation
current or future creditor, or
• Resulted in less value for the debtor than what
should be reasonably expected and the debtor
was already insolvent at the time, or
• Was done even though the debtor knew that they
were not able to repay the creditor as per the
agreement.

What is a Security
• Includes stocks, bonds, or notes and any
interest or instrument commonly known as a
"security."
• Courts have defined a security as requiring
1) an investment in,
2) a common enterprise,
3) to be premised on a reasonable expectation
of profits,
4) to be derived from the managerial efforts of
others.
Securities Act of 1933
• The 1933 Act covers the original issuance
of securities intended for sale to the
public if the transaction or communication
relating to the transaction involves
interstate commerce.
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Securities Exchange Commission
1934 Securities Act created the SEC, which
administers all federal securities law.
The SEC has the following functions and powers:
1. Making the rules.
2. Interpreting the rules.
3. Investigating practices within the securities
markets.
4. Enforcing the rules.
Illegal Under 1933
• The 1933 Act makes it illegal for a person to use
interstate commerce or the mail to do any of the
following things:
1. Sell any security unless a registration statement is in
effect.
2. Carry or transmit a security for the purpose of sale
unless it is accompanied by or preceded by a
prospectus.
3. Offer to sell or buy a security unless a registration
statement has been filed with the SEC.
4. Use any fraudulent schemes, make a material
misstatement of a fact or omit any material information
to defraud the purchaser.

Exempt SECURITIES
• The 1933 Act has a list of securities that are
exempt from the registration requirements.
These securities may be sold and resold as
many times as possible without ever being
subject to the requirements of the 1933
Act.
List of Exempt Securities
• Any security that is given to existing
shareholders where no commission or
payment is made – such as a stock split or
stock dividend.
• Commercial paper with an original
maturity date of less than nine months.
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List of Exempt Securities
• Securities issued for governmental purposes
by (or secured by) governments or other
institutions acting as the government.
• Securities of nonprofit, religious, educational
or charitable organizations.
• Any security that is offered and sold only to
people in a single state by a company
incorporated and doing business in that same
state.
List of Exempt Securities
• Small Issues (Regulation A).
o Must be less than $5,000,000 of securities issued
in a 12-month period,
Must use an “offering circular” instead of a
o
prospectus.
o Regulation A securities can be freely traded after
the original sale.
• Insurance policies or other variable
annuity contracts under other
governmental supervision.

List of Exempt Securities
• Securities offered in a reorganization
subject to court control (bankruptcy).
• Securities issued by an investment
company under the Small Business
Investment Act of 1958.
• Securities sold within 60 days of May 27,
1933.
List of Exempt Transactions
1. Transactions by individuals other than the
issuer, underwriter or dealer
2. Certain transactions by the issuer meeting
Regulation D requirements
3. Private Placement Offerings
4. Certain transactions by the dealer after the
distribution period is over
5. Resale of Restricted Securities and Certain
Sales of Controlled Securities Pursuant to Rule
144
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Exempt TRANSACTIONS
• The default rule is that transactions with
securities need to be registered with the SEC.
• In situations where a transaction is exempt, it
is only this particular transaction that does
not need to be registered.
• Other subsequent transactions with the same
security will either need to be registered
under the requirements of 1933 or be
considered exempt as transactions.
Main Nonexempt Transactions
• Underwriter transactions and dealer
transactions that occur initially after the
security is available for sale to the public
are the transactions that most likely need
to be registered.
 6/19/2017

Rule 504 Rule 505 Rule 506

Regulation D Type of Nonpublic Public and Nonpublic (this means
Company companies not that non-corporations can use this
• There are three different rules in Regulation registered under exemption)
D under which a transaction (in this case 1934 Act

the transaction is the original sale of the Maximum $ Up to $1 million, Up to $5 million, Unlimited
security) may be exempt. Amount within 12 months within 12 months amounts and no
time limit
Types and Any number of Unlimited Same as 505, but
Number of any type – no accredited and all nonaccredited
Investors limitations 35 or fewer non- investors must be
accredited sophisticated
investors

Rule 504 Rule 505 Rule 506 Rule 504 Rule 505 Rule 506
Sale to Allowed Not allowed – issuers must exercise Restrictions on No – there may Yes, the security must be held for
Underwriters reasonable care to assure they are Resale be restrictions on more than 2 years before resale
not selling to underwriters resale of limited
partnership
interests
Disclosure None required If unaccredited – disclosure must
Requirements include audited financial statement
If accredited – no requirements Notifications to Within 15 days of first sale
SEC

General Allowed No Anti-Fraud Yes

Solicitation Provisions
(Advertising)
 6/19/2017

Categories of Investors The Registration Statement

• Unaccredited • The 1933 Act requires that prior to the
• Accredited sale of any security a registration
statement be filed with the SEC.
• Sophisticated
• The information included is supposed to be
all of the information necessary for an
investor to evaluate the security.
• This information is then condensed into a
prospectus.

What is in the Registration Statement SEC Available Actions

1. Basic information
2. Financial information
3. Written consent of any experts
4. Any other material facts that may indicate
that the securities are high risk.
5. Prospectus
• When the registration statement is filed, the SEC
has 20 days in which to stop the registration.
• If no action is taken, the registration automatically
becomes effective after the 20 day waiting period.
• A letter of deficiency identifies a problem in the
registration statement and allows the issuer to fix it
by making amendments to the registration
statement.
• If there is a problem, the SEC can issue a refusal
order.
• The SEC can also issue a stop order.
 6/19/2017

Selling the Issuance Shelf Registration

• After the registration statement and This is when the securities are registered, but
prospectus are filed with the SEC, the issuer not immediately issued. In order to do this,
announces the proposed offering through a the company must:
“red herring” prospectus (this is a
• Continuously update the registration
preliminary prospectus).
statement that was filed, and
• People can make offers after the filing of
the statement but before the effective date. • Have previously issued securities.
• Securities cannot be sold until the
registration is effective.

1933 Act and Fraud

• Prohibits fraudulent activities by people who
offer or sell securities in interstate
1933 and 1934 Acts commerce.
• The 1933 Act provides for criminal penalties
and establishes penalties for fraudulent acts
of up to $10,000 and/or up to 5 years in
prison.
1. Violates any of the rules of the Act of 1933, or
2. Makes an untrue statement of a material fact,
or
3. Omits to state a material fact.

1933 Civil Liabilities
• The Act of 1933 also includes civil liabilities.
The plaintiff must prove the following under
the anti-fraud provisions:
1. The registration statement contained a false
or misleading statement or material
omissions, and
2. The securities purchased were covered by the
defective registration statement, and
3. A loss was incurred (if there is no loss there
are no damages to recover).
1933 Statute of Limitations
• Generally an action needs to be brought
within one year of the discovery of the
misstatement or omission, or one year
from when it should have been discovered.
• In no case is the action able to be started
more than three years after the security is
offered.
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1933 Defenses Against Fraud
Individuals, other than the issuer, will not be
liable when they can prove that:
1. They resigned before the statement was filed,
or informed the SEC of their intent to resign,
or
2. The statement was filed without their
knowledge, or
3. There was reason to believe, after a
reasonable investigation, that the statement
was true and without material misstatement.
Securities Act of 1934
• The 1934 Act focuses on the secondary
offerings of securities and is essentially the
source of the reporting requirements that a
company is forced to follow after it has
issued securities.
• The Act prohibits practices that are
intended to manipulate the price of
security.

1934 Registration Requirements
The following must be registered under the 1934 Act,
even if securities were exempt from registration under
the 1933 Act:
• Corporations with securities:
1. That are traded on a national securities
exchange, or
2. Whose assets are in excess of $10 million and
have a class of stock held by more than 500
people.
• National securities exchanges.
• Brokers and dealers transacting business in
interstate commerce.
1934 Reporting Requirements
• Every issuer registered under the 1934 Act
must file an annual report (10-K) within 90
days of the year-end. These financial
statements must be audited (or certified).
• Unaudited reports need to be filed 45 days
after each of the first 3 quarters (this is a 10-
Q), and an
• 8-K report must be filed within 5 days after
the month in which certain events have
occurred.
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Registration Information
The registration documents that are filed
must include:
• The nature of the business,
• The names of officers and directors,
• The financial structure of the firm, and
• Any bonus and profit-sharing plans.
1934 Anti-Fraud Provisions
• Section 10(b) of the 1934 Act deals with anti-fraud
provisions.
• Even securities that are exempt under the 1933 Act will
fall under the rules of this section.
• Section 10(b)-5 was added to clarify Section 10(b) and
makes it illegal for a person to use interstate commerce,
the mail or any facility of a national security exchange to
do any of the following:
1. Carry out any activity to defraud or deceive.
2. Make an untrue statement of a material fact or to omit to
state a material fact.

SEC Action Under 1934 Act
• The SEC may bring action against an
individual for violation of these rules.
• They may also bring action to prevent a
person from violating them (this is done by
issuing a writ of mandamus).
Proxy Solicitation
An authorization given by a shareholder to another
person for that person to vote on behalf of the
shareholder.
Before a person can be asked for his vote, a written
proxy statement must be be provided.
1. A statement if the proxy is revocable,
2. The identity of the person making the request and
his/her interest in the matter,
3. Information relevant to the voting of new directors,
and
4. A list of matters to be voted on and whether it was
proposed by management or a shareholder.
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Civil Action Under 1934
Individual buyers or sellers may also bring
civil action against others under 1934. A
person:
1. Must prove scienter on the part of the
accused.
2. Demonstrate that he relied on the
misstatements
3. Show that the misstatements were
material.
Tender Offer Reporting
• An offer to all of the shareholders of a class of a
security to buy their shares at a specified price.
• This price is usually higher than the market price.
• The 1934 Act also regulates stock purchases and
tender offers by a person acquiring more than 5%
of the company’s stock.
• Any time a person would acquire more than 5%
of a class of a security, this tender offer must be
registered with the SEC, the market on which the
security is sold, the issuer and with the
shareholders of that class of security.
 6/19/2017

Federal Social Security Act

• The Social Security Act contains provisions
Federal Social Security Act for the following insurance programs
• Old-age, survivors and disability insurance
• Hospital insurance (Medicare)
• Unemployment insurance
• Funding for these programs comes from
either the employer, the employee, or both.

Coverage Under the SSA Classification of “Employees”

• In order to qualify for benefits under the • When an individual performs services for a
SSA, three conditions must be met: business, it is very important that each
1. A person must be an “employee” person is correctly classified as an
employee or as an independent
2. The services that the person performs
contractor.
must be “employment”
3. The compensation that the person receives
must be “wages”
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Being an Employee Employment

• An employee is a person whose • Employment includes all services
performance is subject to the control of an performed by an employee for the
employer. employer.
• Behavioral
• Financial • In order to qualify as employment, the
• Type of Relationship service must be provided on a continuing
or recurring basis.

Old-Age, Survivors, Disabilities and

Wages
• Wages generally includes all earnings,
including non-cash items.
Hospital Benefits (OSDH)
• Financed through payments under Federal
Insurance Contributions Act (FICA) and
Self-Employment Contributions Act.
• Both the employer and the employee are
taxed.
• Employer is liable for additional penalties if
they fail to provide taxpayer ID# or submit
in a timely manner
 6/19/2017

FICA Self-Employment Contributions Act

• Under FICA, both the employer and the • This tax is essentially the FICA tax for self-
employee are taxed on the employee’s employed individuals, with a component
wages at the same rate. for Social Security and a component for
• Under FICA, the employer must withhold Medicare.
the employee’s share of the FICA taxes that
will need to be paid.
• There is a maximum wage base that can
be taxed for FICA; earnings over this base
are not taxed for FICA.

Financing Unemployment Insurance

Programs
• The unemployment insurance program is
financed through payments only by the
employer under both state and federal
Benefits Under the Social
law. Security Act
• The employer also needs to pay State
Unemployment Taxes (SUTA), which may be
adjusted based upon the number of claims
against the employer.
 6/19/2017

OSDH - Benefits Amount of OSDH Benefits

• Availability of benefits is dependent on the • The amount paid is dependent upon
individual obtaining “insured status”.
• A “fully insured” person is eligible for: • Average monthly earnings of the person
• Survivor’s benefits for children • The relationship of the beneficiary to the
• Disability benefits if an injury, no matter where
sustained, will prevent the individual from working retired, deceased or disabled
for at least 1 year
• Benefits for dependents of retired disabled workers
• Medicare payments
• Lump-sum death benefits
• Old-age retirement benefits

Benefits Under Unemployment

Unemployment Insurance Insurance
• Paid by the employer under federal and • Benefits and eligibility regulated at the
state law – it is not deducted from the state level.
employee.
• Most states require substantial past
• The state unemployment tax may be employment.
deducted from the federal amount owed –
up to 90% of the federal amount.

Employee Safety –
Occupational Safety and
Health Act (OSHA)
OSHA Investigations
Can investigate and search an employer’s
premises when there is probable cause.
• Invitation of the employer, or
• Complaint from an employee.
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OSHA
Applies to all employees of business in
interstate commerce except employees of
the federal or state government, or any
industry with specially developed safety
regulations such as mining.
Penalties Under OSHA
• Civil penalties of up to $7,000 per incident.
• Repeated offenses by the employer can lead
to imprisonment.
• OSHA can also impose requirements on
employees.
• Failure to follow OSHA rules is grounds for
firing an employee.
• OSHA can, in serious or repeated cases,
petition the court to issue an order to fire an
employee who violates the rules.

Workers’ Compensation
Workers’ Compensation
• The objectives of the law are:
1. To provide prompt, reasonable benefits and
compensation to work-related accident
victims and their dependents.
2. To provide a single, relatively simple remedy
for victims of work related accidents,
regardless if the employer is at fault or not.
3. To shift the financial burden to industry.
4. To encourage employer interest in employee
safety.
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Workers’ Compensation
• Enacted to enable employees to recover
from injuries, regardless of negligence or
fault.
Coverage Under Workers’
Compensation
• Workers’ Compensation provides coverage
for injuries that occur on the job or in the
course of employment.
• Even if an employee is negligent, they may
collect.
• Employees not covered for self-inflicted
injuries or injuries caused by intoxication.

Provisions of State Laws
• Most state laws have the following in
common
• Not all employees are covered
• Extend coverage to minors.
• Prevent the employee from suing the
employer when they accept benefits from
Workers’ Compensation.
Benefits Under Workers’
Compensation
There are four categories of benefits
1. Cash benefits
2. Medical benefits
3. Death benefits
4. Rehabilitation benefits
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Insurance Requirements for Workers’
Compensation
• Most states require the employer to
purchase insurance.
• If the employer elects not to purchase
insurance they must demonstrate the
financial ability to be self-insured.
Administration of Claims Under
Workers’ Compensation
• Most states handle claims through a state
board or commission.
• Employers are required to report all
injuries.
• Employees are required to notify
employers promptly (within 30 days).
• Employees are required to file their claims
within the specified time.

The Affordable Care Act
Specific Elements for Employers
• “Full-time” employees are those working 30 hours or
more per week.
• “Full-time Equivalent Employees” (FTE) is calculated as
the number of full-time employees plus the combined
number of part-time employee hours divided by 30.
• Whether or not a company must comply with the
mandate is determined by the FTE calculation, but
coverage is required only for full-time employees.
• Employers under the mandate must provide health
insurance for 95% of full-time employees.
• Employees’ dependents must be covered up to age 26.
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Affordable Care Act
• The employer mandate included in the
ACA requires businesses that employ 50 or
more full-time equivalent (FTE) workers to
provide health insurance to their full-time
employees or else pay a penalty.
Specific Elements for Employers
• Coverage does not have to be offered to employees’
spouses.
• Coverage must be “affordable,” meaning that it cannot
cost more than 9.56% of an employee’s income and
must have an average cost sharing of 60%.
• Employees are not required to take their employer’s
coverage, but as long as the employee is offered an
affordable plan then they are not eligible for market
subsidies.
• Employers with over 200 employees must automatically
enroll new employees and offer an opt-out if the new
employee wants to exempt themselves from health
care coverage.

Employer Mandate Penalties
• If an employer who falls under the
employer mandate does not provide
coverage or provides inadequate coverage,
then the employer is fined a per-employee,
per-month Employer Shared
Responsibility Payment fee.
Anti-Discrimination Laws
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Rules of the Fee
• If the employer offers no health care insurance, the
annual fee is $2,000 per full-time employee, except
that the first 30 full-time employees are exempt.
• If at least one full-time employee receives a subsidiary
due to the employer not providing affordable coverage,
then the employer is fined either $3,000 per employee
receiving a subsidy, or $2,000 per employee (after
the first 30), whichever is less.
• Even though the fee is listed as being an annual fee, it
is pro-rated and assessed on a monthly basis.
• The Employer Shared Responsibility Fee is not tax
deductible.
Title VII of the Civil Rights Act of 1964
• Prohibits sexual harassment and
employment discrimination based on race,
color, religion, sex or national origin.
• Applies to all employers in interstate
commerce with 15 employees for at least
20 weeks a year and federal state and local
governments.

The Age Discrimination in
Employment Act
• Protects workers over 40 from
discrimination (intentional or unintentional)
in hiring, firing and compensating.
• Prohibits the mandatory retirement of most
employees.
• Remedies include back pay and affirmative
action.
Equal Pay Act
• The Equal Pay Act prohibits wage
discrimination on the basis of sex.
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Rehabilitation Act of 1973
• This act requires federal contractors and
agencies to take steps in hiring otherwise
qualified handicapped individuals.
• It also prohibits discrimination on the basis
of a handicap.
Americans With Disabilities Act
• This act protects disabled individuals from
discrimination and guarantees equal access
to services in both public and private areas.

The Federal Fair Labor Standards Act
(Wage-Hour Law)
• Applicable to all employers in interstate
commerce.
• Covers maximum hours, minimum wage
and child labor.
• Any employee who works more than 40
hours in a week must receive 1.5 times
their salary for the overtime.
• Minimum wage is set by Congress.
State Level Anti-Discrimination Laws
• Discrimination based on gender/sexual
identity or sexual orientation.
• Discrimination based on religion.
• Discrimination based on political
affiliations.
• Discrimination based on bankruptcy or bad
debts.
• Discrimination against pregnant women.
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Employee Retirement Security Act of
1974 (ERISA)
• Sets standards for employers who choose
to set up a retirement plan for the
employees
• Standards relate to funding and vesting
• A contributory plan is when the employees
pay into the fund
• A noncontributory plan is when the
employees do not pay into the fund
Bona Fide Occupational Qualifications
• Bona Fide Occupational Qualifications refer
to characteristics that would be otherwise
discriminatory, but in the context of a
specific job are allowed.
• Race is never a bona fide occupational
qualification.
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Corporations
• The corporation is a form of business
Corporations enterprise that is set up as a legal entity.

• Its existence is distinct and separate from

those who own and control it.

Tax Classifications Types of Corporations

• C Corp • Domestic corporation
• S Corp • Foreign corporation
• Closely-held corporation
• Publicly-held corporation
• Public corporation (municipal corporation)
 6/19/2017

Advantages of Corporate Structure Disadvantages of Corporations

• Separate legal entity • Formal incorporation process
• Limited liability
• Governmental regulation
• Free transferability of ownership interests
• On-going life • Double taxation on distributed corporate
• Centralized management income
• Single taxation on undistributed corporate
income
• No mutual agency
• Ease of capital assembly

Corporate Formation
• A promoter is an individual who performs
the activities necessary to form a
Corporate Formation corporation.

• The entity usually has no liability for

pre-incorporation contracts.

Corporate Liability for Promoter’s
Contracts
• Exception 1: If a pre-incorporation contract
contains a clause expressly negating the
promoter’s liability, then the promoter will not be
held liable.
• Exception 2: If a corporation adopts a pre-
incorporation contract or otherwise accepts the
benefits of such a contract, then both the
corporation and the promoter are liable.
• Exception 3: If there is a novation, then the
corporation will be liable for pre-incorporation
contracts.
Process of Incorporating
• Corporations are formed under authority of
state statutes.
• The intended corporation usually
incorporates in the state where it intends to
transact business.
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Example: Bruno is a promoter of the Polytone Corporation. Bruno signed a
contract with a CPA, and the contract provided that the CPA would provide
accounting services to Polytone. At the time of contract formation, Bruno did
not inform the CPA that the Polytone Corporation was not yet formed. Before
Polytone’s official incorporation, the CPA performed accounting services, but
he received no payment from either Bruno or Polytone.
If the CPA sues for damages, what will be the result?
Bruno will be liable in his capacity as promoter.
Example: Would your answer change if the CPA also had performed services
for Polytone one month after Polytone’s incorporation?
If the CPA had performed services for Polytone both before and after
incorporation, then both Bruno and Polytone would be liable for the
breach.
Articles of Incorporation
The charter is also referred to as the “Articles of
Incorporation” or “Certificate of Incorporation” and
it details:
• The name of the corporation.
• Its purpose and the nature of its business.
• The authorized number of shares of capital
stock that can be issued with a description of the
various classes of such stock.

Articles of Incorporation
• The amount of indebtedness the corporation may
incur.
• The street address of the corporation’s principal
office.
• A statement of the duties of the officers of the
corporation.
• The names and addresses of the original directors.
• The name and address of the corporation’s
registered agent for receiving service of process and
other notices.
• The length of the corporation’s life, which is usually
perpetual (meaning forever).
Incorporators and First Steps
3) The directors meet to complete the
organizational structure. At this meeting they:
a) Adopt bylaws
b) Elect officers
c) Select the corporate bank and designate
persons authorized to draw checks on the
account.
d) Adopt, ratify or reject pre-incorporation
contracts.
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Incorporators and First Steps
• The individuals who sign the articles of
incorporation are called the incorporators.
• After filing, the following steps must be
carried out by the new corporation:
1. The incorporators elect the directors if
the directors are not named in the articles.
2. The incorporators resign.
Incorporators and First Steps
e) Adopt the form of certificate representing
shares of the company’s stock, and accept or
reject stock subscriptions.
f) Comply with requirements for doing business
in other states.
g) Adopt a corporate seal to be affixed to or
impressed upon corporate documents
required by law to be under seal.
h) Consider all other transactions necessary or
appropriate for carrying on the business
purpose of the corporation.

Defects in Corporation
• Under common law, any entity that did not
follow the above procedures would not
become a corporation.
• De Jure Corporation
• Corporation by Estoppel
• De Facto Corporation
Financing the Corporation – Equity
• Capital is the consideration a company
receives in exchange for shares of its
corporate stock.
• Subscription Agreements are contracts for
future purchases of shares of corporate stock
at specified prices. The purchaser is known as
a subscriber.
1. Pre-incorporation subscribers
2. Post-incorporation subscribers
3. Conditional subscription
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Financing the Corporation - Debt
• Bonds are debt securities issued by a
corporation.
• Debt investors have a right to repayment of
the bond’s principal (corpus) and interest.
Authorized, Issued and Outstanding
• Authorized stock – the stock that is
authorized to be issued in the articles of
incorporation.
• Issued Stock – the portion of authorized
stock that has actually been issued to
shareholders.
• Outstanding Stock – the portion of
authorized stock that has actually been issued
to and is still owned by outside shareholders.

Corporate Liabilities
Piercing the Corporate Veil
• If a corporation is used as a vehicle to
perpetrate fraud or commit some other act
of malfeasance, then the courts can
disregard (ignore) the corporation as a
separate entity and instead hold individual
shareholders or corporate officers liable for
wrongdoing perpetrated by the
corporation.
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Corporate Liabilities
• A corporation is liable for the contracts of
its employees and, in particular situations,
for torts committed by employees.
• Respondeat Superior
• Ultra Vires Doctrine
Piercing the Corporate Veil
1. Fraudulently inducing someone into
dealing with the corporation rather than
the individual.
2. Undercapitalization
3. Commingling personal and corporate
assets
4. Failure to act as a corporation

Directors and Officers
Authority of Directors
• The right to manage the affairs of the
corporation is vested in (given to) the board
of directors.
• The board of directors can initiate
fundamental changes, such as selling
substantially all of the corporation's assets,
dissolving the corporation, or amending the
articles of incorporation, but these changes
require approval by the shareholders.
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Election and Removal of Directors
• One of the most important functions of the
shareholders is to elect the board of directors.
• A director usually serves a one-year term,
although the articles or bylaws may provide
for a longer term.
• In most states, shareholders may, by a
majority vote, remove a director or the entire
board of directors with or without cause.
Determining Corporate Policy
• The board of directors determines overall
corporate policy through:
1. Financial decisions, such as the declaration of
dividends.
2. Authorization of major policy decisions (for
example, new product lines).
3. Selection and removal of officers and setting
their compensation. (Directors can fix their
own compensation unless the articles or
bylaws provide otherwise.)

Duties of Board of Directors
• Individual directors are not agents of the
corporation because they can’t act
individually to bind the corporation.
• Directors are fiduciaries who must
perform their duties in good faith, with due
care, and in the best interests of the
corporation.
Duty of Loyalty
• A director must fully disclose any financial interest he or
she may have in any transaction to which both the
director and the corporation may be a party.
• A transaction, however, does not need to be voided
simply because of a director’s conflict of interest.
• The corporation can rescind a contract between a director
and the corporation that doesn’t meet these criteria.
• A transaction is fair if reasonable persons in an arm’s-
length transaction would have bound the corporation to
the bargain.
• Directors cannot usurp corporate business opportunities.
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Duty of Care
• The duty of care states that a director shall
discharge his/her duties in good faith, with the care
an ordinarily prudent person in a similar position
would exercise under similar circumstances, and in
a manner believed to be in the best interests of the
corporation.
• A director has not exercised the required care if
he or she doesn’t attend meetings, fails to analyze
corporate financial statements or review legal
opinions pertinent to corporate activities, and
doesn’t become conversant with the available
information relevant to his/her duties.
Business Judgment Rule
Directors of a corporation are assumed to make
decisions in the best interest of the company, and are
thus protected from personal liability for their actions
based upon the “business judgment rule.”
As long as directors do the following, the courts will
refuse to review their actions:
1. Use good faith when performing their duties
2. Take reasonable care of a prudent person when
performing their duties
3. Believe that their decisions are in the best interest
of the company
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Officers
• In most jurisdictions, the major officers
are elected by the board of directors and
serve at the board's disposal. Stockholders’ Rights and
Obligations
• Officers are responsible for the day-to-day
running and operation of the business.

• The usual rules of agency apply to

officers.

Stockholder Rights Common Rights

• Anyone who holds one or more shares of a • The power to remove directors for cause.
corporation’s stock is part owner of the
business.
• However, shareholders do not have the • The right to inspect corporate records
right to manage the corporation directly, as after presentation of a written request.
this is done by the officers.
• The shareholders’ primary participation in • The preemptive right.
corporate policy and management is
meeting annually and electing directors.

Other Rights
• Derivative action
• Asset share on dissolution
• Dividends
• Shareholder meetings
• Voting rights
Asset Share on Dissolution
• Upon liquidation of a corporation, the
stockholders have the right to their
proportionate shares of any remaining
assets or proceeds from those assets after
the creditors are paid.
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Derivative Action
• A derivative action is a lawsuit instituted by
a large group of shareholders on the
corporation’s behalf.
Dividends
• A corporation’s board of directors has the
authority to declare dividends. However,
there is no requirement that a
corporation actually do so.
• Once a dividend is declared and
shareholders are notified, the dividend
becomes an irrevocable debt.

Illegal Dividends
• However, if payment of the dividend would
make the corporation insolvent, then the
dividend declaration is illegal and
shareholders must repay any dividends
received.
• Any director who votes for, or otherwise
assents to, an illegal dividend is personally
liable for damages resulting from the
payment of the illegal dividend.
Special Meetings
• Special shareholder meetings can be called
whenever an issue arises that requires
shareholder action, such as the approval of
a merger.
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Shareholder Meetings
• Shareholders exercise their rights at annual
or special meetings. Annual meetings are
required and must be held at a time fixed
in the bylaws.
• Their purpose is to elect new directors and
to conduct necessary business.
• Notice of an annual meeting is usually not
necessary because the time and place of
such events should be stated in the bylaws.
Fundamental Changes
• Fundamental corporate changes require
shareholder approval.
• Under the Revised Model of Business
Corporation Act, the first step is approval of
the change by the board. All shareholders,
including those without voting rights, must
then be notified regarding the matter.
• A majority vote of the shareholders taken at
an annual or special meeting is sufficient to
pass the proposal unless the articles require a
greater percentage.

Having Shareholder Meetings
• A quorum of the outstanding shares must
be represented in person or by proxy to
conduct business at a shareholders’
meeting.
• Resolutions are usually adopted by a
simple majority of voting shares.
• Shareholders can ordinarily act only at a
duly called meeting.
Voting for Directors
To mitigate the sometimes-harsh effect of
straight voting on minority shareholders, most
states permit or require cumulative voting.
Staggering the terms of directors may prevent
the minority shareholders from enjoying the
advantages of cumulative voting.
Another alternative to straight voting is what’s
known as class voting.
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Voting Rights
• Unless a class of stock is established with
no voting rights (nonvoting stock) or the
articles of incorporation provide for more
or less than one vote per share, each
shareholder is entitled to one vote for each
outstanding share owned.
Shareholder Control Devices
1. Voting Agreement
2. Voting Trusts
3. Proxies
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1. Voting Agreement 2. Voting Trusts

• Shareholders are free to agree • A voting trust occurs when shareholders
contractually upon how they will vote their transfer legal title to their shares to one or
shares. more trustees, who vote for the shares.

• A voting agreement can be perpetual in • The trustees can vote the shares based on
existence and kept secret from other instructions in the trust agreement or can
shareholders. be allowed to use their own discretion.

3. Proxies Revoking a Proxy

• Because many shareholders are unable to A proxy can be revoked at any time by
attend meetings, they sometimes delegate • signing a new proxy,
authority to vote their shares by issuing
• the shareholder’s voting of his/her shares
proxies.
at the shareholder meeting, or
• the shareholder’s death.
• A proxy authorizes someone else to vote
on the shareholder’s behalf.

Types of Proxies
• A general proxy permits a holder to vote
on all corporate proposals other than
fundamental corporate changes.
• A limited proxy permits voting only on
specified matters.
Fundamental Changes
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Liabilities of Shareholders
• The liability of a shareholder is generally
limited to his or her capital investment.
• A shareholder is liable to the corporation or
its creditors for any unpaid portion of his or
her stock subscription contract.
• A shareholder who knowingly or unknowingly
receives illegally declared dividends is liable
for repayment of the dividend amount to an
insolvent corporation.
Fundamental Changes
• The structure of a corporation can be
altered in a number of different ways.
1. Merger or consolidation
2. Quasi reorganization
3. Dissolution
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1. Merger Appraisal Remedy

• A business transaction in which an acquiring • A copy of the merger plan must be sent to
firm absorbs a second firm, and the acquiring
firm remains in business as a combination of each shareholder of record of the
the two merged firms. subsidiary corporation and the subsidiary
• Approval of the shareholders of each firm corporation's dissenting stockholders
and the board of directors of each firm is must be given an appraisal remedy.
required, and the stockholders of both
corporations must be given a copy of the
merger plan as well as proper notice of a
special meeting at which the merger plan will
be presented.

Consolidation 2. Quasi Reorganization

• A consolidation is similar to a merger, but • A quasi-reorganization is a reorganization
a new company is formed and neither of or revision of the capital structure, which is
the merging companies survives. permitted in some states.

• Must be approved by the shareholders of • This procedure eliminates an accumulated

both companies. deficit as if the company had been legally
reorganized without much of the cost and
difficulty of a legal reorganization.

3. Dissolution
• A corporation’s life may terminate either
through (1) voluntary action on behalf of
the shareholders or through (2) some
involuntary means.
• After dissolution, the affairs of the
corporation must “wind up” or be
liquidated.
Involuntary Dissolution
• Involuntary dissolution is the result of
either
A. Administrative action or
B. Judicial action.
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Voluntary Dissolution
• Voluntary dissolution requires the passage
of a resolution. There are two steps to this
process.
1. A majority of the corporation’s board of
directors must pass such a resolution, and
2. A majority of the voting shareholders must
approve.
A. Administrative Dissolution
• If the corporation fails to comply with
applicable state laws or if some other
deficiency exists, then the Secretary of
State (of the state of incorporation) has the
authority to dissolve the corporation.
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B. Judicial Dissolution
A suit for judicial dissolution can be brought
by the corporation’s shareholders and
creditors.
Commonly, such suits are brought by
shareholders when:
• The corporation has acted illegally, or
• The corporation’s management has used
the corporation’s assets frivolously
(wastefully).