Corporate bargain--limited liability
I. CHARACTERISTICS OF A CORPORATION
A. PRINCIPAL CHARACTERISTICS OF A CORPORATION
a) Entity Status--a corporation is a legal
entity created under the
authority of legislature
b) Limited Liability--as a legal entity, a
corp is responsible for
its own debts; its sh’s liability is limited to their
investment;
c) Free Transferability of Interest--shares,
representing ownership
interests, are freely transferable;
d) Centralized Management and Control--a
corp’s management is
centralised in a board of dirs and officers. Shs have no direct control
over
the board’s activities;
e) Duration--Continuity of Existence--a
corp is capable of perpetual
existence;
f) Taxation--a corp, as an entity, pays
taxes on its own income; shs
are taxed only on dividends;
g) Remember Attributes of the Corporation--CLIFF:
1) Centralization
of management; 2) Limited liability; 3) Forever (perpetual duration) ;
4)
Freely alienable (shares can be sold) .
B. CORPORATIONS DISTINGUISHED FROM OTHER FORMS OF
BUSINESS ASSOCIATIONS.
1. GENERAL PARTNERSHIPS--in most states,
p’ships are governed by the
Uniform Partnership Act (UPA) . However, the Revised UPA (RUPA) has
been
adopted by a few states a) Aggregate Status--a
p’ship is an aggregation
of two or more persons who are engaged in business as co-owners.
Although not a
legal entity, a p’ship is treated as one for certain
purposes, e. g., ownership
and transfer of property. RUPA confers entity status on
p’ships; b)
Unlimited Liability--every partner is subject to unlimited
personal
liability on p’ship debts; c) Transferability of
Interests--a partner
cannot make a transferee a member of the p’ship. She can,
however, assign his
interest in the p’ship, thus permitting the assignee to
receive distributions
of profits. Because the assignee does not become a member of the
p’ship, he is
not entitled to participate in p’ship business or management.
d) Duration and Dissolution--a
p’ship cannot have perpetual
existence. It is terminable at will unless a definite term is expressed
or
implied, and is also dissolved by death, incapacity, or withdrawal of
any
partner.
1) Wrongful dissolution--p’ships can also be
dissolved in contravention of
the p’ship agreement, by the express will of any partner, by
a court or by a
partner’s conduct. Upon wrongful dissolution, non-breaching
partners may seek
damages for breach and, if they choose to do so, may continue the
p’ship upon
payment to the breaching partner of the value of his interest.
1) Compare--dissociation under RUPA--termination results in
either the
winding up of the p’ship or buyout of the dissociating
partner, depending on
the event triggering the termination. A buyout may be reduced by
damages if
dissociation was wrongful.
e) Management and Control--absent a
contrary agreement, every partner
has a right to participate equally in the partnership management.
f) Authority--each partner, as an agent of
the firm, may bind the
p’ship by acts done for the carrying on, in the usual way,
the business of the
p’ship.
1) RUPA--a p’ship is bound by a partner’s
act for carrying on in the usual
way either the actual p’ship business or a
business of the kind
carried on by the p’ship.
g) Ownership of Property--title may be held
in the name of the
p’ship, but property is owned by the
individual partners as tenants in
p’ship. There is no tenancy in p’ship under RUPA,
which provides that property
acquired by p’ship is owned by p’ship, not
individual partners.
h) Capacity to Sue and be Sued--under the
UPA, a lawsuit may be
brought by or against individual partners, rather than
p’ship. Partners are
jointly and severally liable for wrongful acts and breaches of trust;
they are
only jointly liable for debts and obligations of the p’ship.
1) Statutory reforms--many state statutes specifically allow a
p’ship to be
sued in its own name. Other states make all p’ship
liabilities joint and
several. Other reforms provide that not all joint obligors need to be
joined in
a suit.
2) RUPA--a p’ship may sue and be sued in its own
name, and partners are
jointly and severally liable for all
p’ship obligations. A claim against
the p’ship cannot be satisfied from a partner’s
personal assets unless p’ship
assets have been exhausted.
2. JOINT VENTURE--a p’ship formed
for some limited investment
or operation, as opposed to a continued business enterprise. Joint
ventures are
governed by the rules applicable to p’ships 3.
LIMITED PARTNERSHIP--this
is a p’ship consisting of two classes of partners: general
partners (with
rights and obligations as in an ordinary p’ship) and limited
partners (with no
control and limited liability) .
4. LIMITED LIABILITY PARTNERSHIPS--in a
LLP, a general partner is NOT
personally liable for all p’ship
obligations arising from negligence,
wrongful acts, and misconduct absent his involvement in the misconduct.
There
is no exclusion for liability for contractual obligations.
5. LIMITED LIABILITY COMPANIES--LLC is a
non-corporate business
entity whose owners (members) have limited liability and can
participate actively
in its management. An LLC may be either for a term or at will. It can
be
managed either by its members, or non-member managers. Depending on the
statute, distributions are made either equally to each member or in
proportion
to each member’s contribution.
a) Withdrawal and Dissolution--some
statutes provide that any event
that terminates a member’s membership (death, resignation)
causes dissolution.
Other statutes distinguish between fault events(member misconduct...)
and
non-fault events (death, bankruptcy) , and some provide that
dissolution can be
avoided by paying the withdrawing member fair value for his interest.
b) Advantages of LLCs--An LLC for a
business association, not
publicly held, has strong advantages: partnership taxation, virtually
no
restrictions in structuring ownership interests and management, limited
liability for owners and managers, and no limitations on the number or
nature
of owners.
C. DISREGARD OF CORPORATE ENTITY--since
a corp is a distinct
legal entity, shs are normally shielded from corporate obligations. In
certain
instances, however, the corporate entity will be disregarded.
1. PIERCING THE CORPORATE VEIL--(Suits by
corporate creditors against
shs) --it’s more common in contract claims than in
tort claims. The most important
elements considered by the courts: a) Commingling of Assets--commingling
of corp assets and personal assets of shs (e. g., paying private debts
with
corp funds) may lead to piercing of the corporate veil; b)
Lack of Corporate
Formalities--whether basic corp formalities (e. g., regular
meetings,
corporate records maintained, issuance of stock) were followed is also
relevant. Statutory close corps are permitted more flexibility
regarding corp
formalities; c) Undercapitalisation--if the corp
was organised without
sufficient capital or liability insurance to meet obligations
reasonably
expected to arise, the corp veil may be pierced; d)
Domination and Control
By Shareholder--the corp veil is often pierced when an
individual or other
corp owns most or all of the stock, so that it completely dominates
policy or
business decisions.
e) ” Alter Ego,”
“Instrumentality,” “Unity of
Interest” --when no
separate entity exists and the corp is merely the alter ego or
instrumentality
of its shs (could be a corporate shareholder) , or when there is a
unity of
interest between the corp and its shs, the corp veil is often pierced.
These
terms are usually applied only if other grounds are present; f)
Fraud,
Wrong, Dishonesty, or Injustice--generally, the veil will be
pierced only
if one of these elements is available, e. g., no piercing of veil if
there is a
lack of corp formalities without resultant injustice. Piercing the veil
usually
involves corps with a small number of shs.
2. PIERCING HAPPENS MOST OFTEN WHEN: 1) The
number of shs is
small--the chance of one sh dominating the corp is greater; 2)
Deception--There
is some kind of deception; 3) Agency--individual is a
“principal” and corp is
his “agent” 4) Estoppel--outsider was led to
believe that he was dealing with an
individual, while in fact he was dealing with the corporation.
5) Direct tort--individual and corp acted together and should
be
jointly/severally liable 6) Instrumentality requirement is satisfied:
I)
control of a subsidiary by parent ii) to commit fraud iii) to cause
loss or
injury.
3. PIERCING THE WALL BETWEEN AFFILIATED CORPORATIONS--this
occurs
when a P with a claim against one corp attempts to satisfy the claim
against
the assets of an affiliated corp under common ownership. This type of
aggregation
is permitted only when each affiliated corp is NOT a freestanding
enterprise
but merely a fragment of an entity composed of affiliated corps.
4. USE OF CORPORATE FORM TO EVADE STATUTORY OR
CONTRACT OBLIGATIONS--the
corp form may be ignored when it is used to evade a statutory or
contractual
obligation. The issue is whether the contract or statute was intended
to apply
to the shs as well as the corporation. Only third parties,
not the corp
or its shs, are generally allowed to disregard the corp entity.
5. TWO EXTREMES TO AVOID IN PIERCING THE CORPORATE
WALL:
a) Old model--Superman (sh) used corp as
his puppet; b) New Model--Superman
(sh) and corp are inseparable (alter ego)
D. SUBORDINATION OF SHAREHOLDER DEBTS--”
DEEP ROCK” DOCTRINE--if a
corp goes into bankruptcy, debts to its controlling shs may be
subordinated to
claims of other creditors. When subordination occurs, shareholder loans
are
treated as if they were invested capital (stock) .
Major factors in
determining whether to subordinate include fraud, mismanagement,
undercapitalization, commingling, excessive control, etc.
II. ORGANIZING THE CORPORATION--generally,
corps are created
under and according to statutory provisions of the state in which
formation is
sought.
A. FORMALITIES IN ORGANIZING CORPORATION: 1.
CERTIFICATE OR
ARTICLES OF INCORPORATION--state law governs the content of
the articles,
which are filed with the secretary of the state. Usually, the articles
must
specify the corp name, number of shares and classes of stock
authorised,
address of the corp’s initial registered office, name of
initial registered
agent, and the name and address of each incorporator.
a) Purpose Clause--under most statutes, no
elaborate purpose clause
is needed. It is sufficient to state that the purpose of the corp is to
engage
in any lawful business activity.
b) State of Incorporation--incorporators
need to consider how
flexible the state’s corporate law is versus the costs
associating with
incorporating in that state 2. ORGANIZATIONAL MEETING--filling
the
articles in proper form creates the corporation, after which an
organisational
meeting is held by either the incorporators or dirs named in the
articles.
Matters determined at meeting: 1) Incorporators elect directors, if no
dirs are
named in the articles; 2) Directors choose officers; 3) Directors
ratify
pre-incorporation transactions; 4) Directors authorise issuance of
shares 5)
Directors adopt by-laws (if necessary) , corporate seal and stock
certificate
B. DEFECTS IN FORMATION PROCESS--” DE
JURE” AND “DE FACTO” CORPS--when
there is a defect or irregularity in formation, the question is whether
the
corp exists “de jure,” “de
facto,” “by estoppel,” or not at all.
This issue
usually arises when a third party seeks to impose personal liability on
would-be
shs. Another method of challenging corporate status, used only by the
state, is
a quo warranto proceeding. Note: where there has
not been compliance
with the statute, we apply principles of de facto, de jure and corp by
estoppel. Where there has been compliance with the statute, we apply
principles
of disregard of corporate fiction, a/k/a “piercing the
corporate veil,” which
is an exception, rather than a rule.
1. DE JURE CORPORATION--this exists when
the corp is organised in
compliance with the statute. Its status cannot be attacked by
anyone--not
even the state. Most courts require only “substantial
compliance” ; others
require exact compliance with the mandatory requirements.
2. DE FACTO CORPORATION (substantially
abolished) --this exists when
there is insufficient compliance as to the state (i. e., state can
attack in
quo warranto proceeding) , but the steps taken are sufficient to treat
the
enterprise as a corp with respect to its dealings with third parties.
Requirements: 1) Colorable or apparent attempt; 2) Good faith; 3) Some
use of
corporate franchise; Then ct will recognise status as to all but state 3.
CORPORATION BY ESTOPPEL
a) Definition--estoppel is an equitable
evidentiary rule which
prevents a party from denying the existence of a fact notwithstanding
that he
fact is not true. Thus, certain parties are estopped from asserting
defective
incorporation when they have dealt with the corp as though properly
formed.
b) Example--shs who claimed corp status in
an earlier transaction are
estopped to deny that status in a suit brought against the corp. The
estoppel
theory normally does NOT apply to bar suits against would-be shs by
tort
claimants or other involuntary creditors.
c) Overlap With De Facto--many of the facts
which we would point to
support a claim of de facto status are the same ones we point for
estoppel.
However, substantial abolition of de facto concept doesn’t
necessarily abolish
estoppel.
d) De Facto is For All; Estoppel is For One--estoppel
depends on
relationship between party and corp.
4. WHO MAY BE HELD LIABLE--when a would-be
corp is not a de jure or
de facto or a corp by estoppel, the modern trend imposes personal
liability
against only those owners who actively participated in management of
the
enterprise.
5. EFFECT OF STATUTES: a) On De
Facto Doctrine--states
following the prior version of the Model Act have abolished the de
facto
doctrine, thus making all purported “shs” jointly
and severally liable for all
liabilities incurred as a result of the purported
“incorporation.” However,
statutes based on Revised Model Business Corporation Act require a
person
acting on behalf of the enterprise to know that
there was no
incorporation before liability attaches.
b) On Estoppel Doctrine--the effect of both
acts is an unsettled issue.
c) On Liability--under the prior Model Act,
liability extends to
investors who also exercise control or actively participate in policy
and
operational decisions. It is expected that the Revised Model Act will
be
interpreted in the same manner.
III. LIABILITIES FOR TRANSACTIONS BEFORE
INCORPORATION.
A. PROMOTERS--a promoter participates in
the formation of the corp,
usually arranging compliance with the legal requirements of formation,
securing
initial capital, and entering into necessary contracts on behalf of the
corp
during the time it’s being formed.
a) Fiduciary Duties to Each Other--Full disclosure
and fair
dealing are required between the promoters and the corp and
among promoters
themselves.
B. CONTRACTS MADE BY PROMOTERS ON
CORP’S BEHALF
1. RIGHTS AND LIABILITIES OF CORPORATION: a)
English Rule--the
corp is not directly liable on pre-incorporation
contracts even if later
ratified. Rationale: the corp was not yet in existence at the time the
promoter
was acting.
b) American Rule--the corp is liable if it
later ratifies or adopts
pre-incorporation K.
c) Corporation’s Right to Enforce Contract--under
either rule, the
corp may enforce the contract against the party with whom the promoter
contracted, if it chooses to do so.
2. RIGHTS AND LIABILITIES OF PROMOTERS.
a) Liability on Pre-incorporation Contract--generally,
promoters are
liable if the corp rejects the pre-incorporation contract, fails to
incorporate, or adopts a contract but fails to perform, unless
the
contracting party clearly intended to contract with
the corporation only
and not with the promoters individually.
b) Right to Enforce Against the Other Party--if
a corp is not formed,
the promoter may still enforce the contract.
C. OBLIGATIONS OF PREDECESSOR BUSINESS--a
corporation that
acquires all of the assets of a predecessor business does not
ordinarily
succeed to its liabilities, with exceptions: a) Exceptions--the
successor corp may be liable for its predecessor liabilities if: 1) the
new
corp expressly or impliedly assumes the predecessor obligations (the
creditors
of the old corp may hold the new corp liable as third-party
beneficiaries)
; 2) the sale was an attempted fraud on the
creditors; or 3) the
predecessor is merged into or absorbed by the successor.
IV. POWERS OF THE CORPORATION.
A. CORPORATE POWERS--generally, corporate
purposes and powers are
those expressly set forth in the
corporation’s articles, those conferred
by the statute, and the implied powers necessary
to carry out the
express powers. Transactions beyond the purposes and powers of the
corporation
are ultra vires. 1. TRADITIONAL PROBLEM AREAS--the
following three
powers are particularly significant express powers, since older
statutes did
not specifically confer them: a) Guarantees--modern
statutes confer the
power to guarantee the debts of others if it is in furtherance of the
corporate
business; b) Participation in a Partnership--present-day
statutes
explicitly allow the corp to participate with others in any corp,
partnership,
or other association; c) Donations--because the
general rule is that the
objective of a business corporation is to conduct business activity
with a view
to profit, early cases held that charitable contributions were ultra
vires; the
modern view permits reasonable donations without
showing the probability
of a direct benefit to the corp.
B. AGENCY
1. DEFINITION--agency is the fiduciary
relation which results from
the manifestation of consent by one person to another that the other
shall act
on his behalf and subject to his control, and consent by the other to
so act.
" Rest2dAg a) Parties to an agency relationship--Principal
&
Agent. Thus, three essential elements of an agency relationship: 1)
Manifestation by principal that agent shall act for him in some
undertaking; 2)
Acceptance by the agent; and 3) Understanding that the principal is in
control
of the undertaking.
I) Note that these are factual issues; if they are satisfied,
then the
relationship is one of agency, regardless of what the parties
themselves call
it (but the parties' labels may provide evidence of their intent) 2.
CATEGORIES OF AGENCY
a) Actual Express Authority--authority is
the power of the agent to
affect the legal relations of the principal by acts done in accordance
with the
principal's manifestations of consent to him. " Rest §7.
Operative word is
"manifestation". If he says, do something, it's express -- but the
manifestation may include implied assent to other things as well, which
is--> b) Actual Implied Authority--unless
otherwise agreed, authority
to conduct a transaction includes authority to do acts which are
incidental to
it, usually accompany it, or are reasonably necessary to accomplish it.
"
Rest § 35 c) Apparent Authority -- a. k.
a. "ostensible
authority"--apparent authority is the power to affect the legal
relationships of another person by transactions with third persons,
professedly
as agent for the other, arising from and in accordance with the other's
manifestations to such third persons. " Rest §8. But note that
the
manifestation includes allowing the agent to represent accurately his
own
authority.
d) Inherent Authority--this is the
authority that inheres in an
office. General agent (agent authorized to conduct a series of
transactions
involving continuity of service) : P is bound if A is acting in the
interests
of P and A does an act usual or necessary with respect to the
authorized
transactions ; 1) Unusual activities--depositing corporate checks on a
personal
account is an unusual activity, and the bank should make inquiry if the
person
is authorized to do that; otherwise, the bank is liable to the
principal for
lost money (Mohr) e) Ratification--ratification is
the affirmance by a
person of a prior act which did not bind him but which was done or
professedly
done on his account, whereby the act, as to some or all persons, is
given
effect as if originally authorized by him. " Rest § 82. The
principal can
affirm by words, or by deeds. This includes the failure to repudiate
the
subject matter when presented, suing to enforce the obligation,
retaining the
benefits of the transaction. Note several things: 1) Ratification
assumes that
the principal was not previously bound. If the principal had been
previously
bound, then the liability would be based on another agency theory.
2) It doesn't matter to whom the affirmance is made. It could
be to the
agent, to the third party, or anyone else or nobody at all. Why?
Because what
was lacking in the original contract was merely his expression of
assent to the
relationship of agency. The terms are fixed, the third party believes
he has an
agreement, all that's missing is the opposite party. So the President
of the
firm's note to himself that the affirms may be sufficient. If there are
some
formalities required to authorize an act --e. g., sealed instruments,
deeds --
then there might be additional formality required for affirmance.
f) Estoppel--purported principal either (a)
intentionally or
carelessly causes the belief that a purported agent is acting on his
behalf, or
(b) sits silently knowing that such belief exists without taking
reasonable
steps, and the third party relies detrimentally.
C. ULTRA VIRES TRANSACTIONS--those
beyond the purposes and
powers, express and implied, of the corporation. Under common law,
shareholder
ratification of an ultra vires transaction nullified the use of an
ultra vires
defense by the corporation.
1. TORT ACTIONS--ultra vires is NO defense
to tort liability.
2. CRIMINAL ACTIONS--claims that a
corporate act was beyond the
corp’s authorized powers are NO defense to criminal
liability.
3. CONTRACT ACTIONS--at common law, a
purely executory ultra
vires contracts were NOT enforceable against either party;
fully
performed contracts could NOT be rescinded by either party; and, under
the
majority rule, partially performed contracts were generally enforceable
by the
performing party, since the non-performing party was estopped to assert
an
ultra vires defense.
4. STATUTES--most states now have statutes
that preclude the use of
ultra vires as a defense in a suit between the contracting parties, but
permit
ultra vires to be raised in certain other contexts: a) Suits
Against
Officers or Directors--if performance of an ultra vires
contract results in
a loss to the corp, it can sue the officers or dirs for damages for
exceeding
their authority.
b) Suit By State--these limiting statutes
do NOT bar the state from
suing to enjoin a corp from transacting unauthorised business.
c) Broad Certificate Provisions--when the
certificate of
incorporation states that the purpose is to engage in any lawful
activity for
which corp may be organized, ultra vires is unlikely to arise.
V. MANAGEMENT AND CONTROL
A. ALLOCATION OF POWERS BETWEEN DIRECTORS AND
SHAREHOLDERS
1. MANAGEMENT OF CORPORATION’S BUSINESS--corporate
statutes vest the
power to manage in the board of directors, except
as provided by valid
agreement in a close corp. He board’s power is limited to
proper purposes.
2. SHAREHOLDER APPROVAL OF FUNDAMENTAL CHANGES--shs
must approve
certain fundamental changes in the corp, e. g., amendment of articles,
merger,
sale of substantially all assets, and dissolution.
3. POWER TO ELECT DIRECTORS--shs have the
power to elect dirs and to
remove them for cause, absent provisions for
removal without cause in
the certificate, bylaws, or in statutes. Some statutes also permit the
board or
the courts to remove a dir for certain specific reasons (e. g., felony
conviction) .
4. POWER TO RATIFY MANAGEMENT TRANSACTIONS--shs
have the power to
ratify certain management transactions and insulate the transactions
against a
claim that managers lacked authority, or shift the burden on the issue
of
self-interest.
5. POWER TO ADOPT PRECATORY RESOLUTIONS--shs
may also adopt advisory
but nonbinding (precatory) resolutions on proper subjects of their
concern.
6. BYLAWS--shs usually have the power to
adopt and amend bylaws,
although some statutes give the board of dirs the concurrent power to
do this.
7. CLOSE CORPORATION--this is a corp owned
by a small number of shs
who may actively manage; it has no general market for its stock, and it
has
some limitations regarding transferability of stock.
8. STATUTORY CLOSE CORPORATION STATUS--the
basic requirements to
qualify for special treatment under the statutes are that, in its cert
of
incorp’n, a statutory close corp must identify itself as
such, and must include
certain limitations as to the number of shs, transferability of shares,
or
both.
a) Functioning As a Close Corporation--there
may be sh agreements
relating to any phase of the corp affairs.
B. DIRECTORS
1. APPOINTMENT OF DIRECTORS--initial dirs
are either designated in
the articles of incorporation or elected at a meeting of incorporators.
Subsequent elections are by shs at their annual meetings. The number of
dirs is
usually set by the articles or bylaws.
a) Qualifications--absent a contrary
provision in the articles or
bylaws, dirs need not be shs of the corp or residents of the state of
incorporation.
b) Vacancies--statutes vary, but under
Model Act, a vacancy may be
filled by either the shs or dirs.
1) Compare--removal: some statutes require that vacancies
created by removal
of a dir be filled by the shs unless the articles or bylaws provide
otherwise.
2. TENURE OF OFFICE
a) Term of Appointment--under most
statutes, office is held until the
next meeting, although on a classified board, dirs may serve staggered
multi
year terms.
b) Power to Bind Corporation Beyond Term--unless
limited by the
articles, the board has the power to make contracts biding the corp
beyond the
dirs’ term of office.
c) Removal of Director During Term--at
common law, shs can remove a
dir for cause (e. g., fraud, incompetence,
dishonesty) unless an article
or bylaw provision permits removal without cause. a dir being removed
for cause
is entitled to a hearing by shs before a vote to remove. a number of
statutes
permit removal without cause.
1) Removal by Board--board can NEVER
remove a dir unless authorised
by statute; 2) Removal by Court--there is a split authority as to
whether a
court can remove a dir for cause.
I) Statutes--some statutes permit courts to remove a dir for
specified
reasons. Usually, a petition for removal can be brought only by a
certain
percentage of shs or the attorney general.
3. FUNCTIONING OF BOARD
a) Meetings--absent a statute, dirs can act
only at a duly convened
meeting consisting of a quorum. In most jurisdictions, a meeting can be
conducted by telephone or other means whereby participants can hear
each other
simultaneously. Most statutes also allow board action by unanimous
written
consent without a meeting.
1) Notice--although formal notice is unnecessary for a regular
meeting,
special meetings require notice to every dir of date, time, and place.
Usually,
notice can be waived in writing before or after a meeting. Attendance
waives
notice unless the dir attends only to protest the meeting.
2) Quorum--a majority of the authorised
number of dirs constitutes a
quorum. Many statutes permit the articles or bylaws to require more
than simple
majority or less than that.
3) Voting--absent a contrary provision, an affirmative vote of
a majority of
those present, not a majority of those voting, is
required for board
action.
b) Effect of Non-compliance With Formalities--today,
most courts hold
that informal but unanimous approval of a
transaction is effective,
as is a matter receiving the explicit approval by a majority of dirs
without a
meeting, plus acquiescence by the remaining dirs.
c) Delegation of Authority--the board has
the power to appoint
committees of its own members to act for it either in particular
matters or to
handle day-to-day management between board meetings. Typically, these
committees cannot amend the articles or bylaws,
adopt or recommend major
corporate changes (e. g., merger) , recommend dissolution, declare a
dividend,
or authorise issuance of stock unless permitted by
the articles or
bylaws. Note that while the board may delegate operation of the
business to an
officer or management company, the ultimate control must be retained by
the
board.
d) Provisional Directors--some statutes
allow them to be appointed by
court if the board is deadlocked and corporate business is endangered.
a
provisional dir serves until the deadlock is broken or until removed by
a court
order or by majority of shs.
e) Voting Agreements--an agreement in
advance among dirs as to how
they will vote is void as contrary to public policy. There are certain
exceptions for statutory close corps.
4. COMPENSATION--dirs are NOT entitled to
compensation unless they
render extraordinary services or such compensation is otherwise
provided for.
Officers are entitled to reasonable compensation for services.
5. DIRECTORS’ RIGHTS, DUTIES, AND
LIABILITIES a) Right to Inspect
Corporate Records--if done in good faith
for purposes germane to his
position as dir, this right is absolute.
b) Duty of Care--dirs must exercise the
care of an ordinarily
prudent and diligent person in a like position, under similar
circumstances. There is no liability (absent a conflict of interest,
bad faith,
illegality, or gross negligence) for errors of judgement (business
judgement
rule--the rebuttable presumption that action was taken on an
informed
basis, in good faith and exercising reasonable care) , but the dir must
have
been reasonably diligent before the rule can be invoked (Shlensky) 1)
The duty
of care requires: I) Education--a dir should acquire at least a
rudimentary
understanding of the business of the corporation; ii) Information--a
dir is
under a continuing obligation to keep informed about the activities of
the
corp; iii) Participation--dirs must “generally
monitor” corporate affairs, but
need NOT involve themselves in the day-to-day operations; (i. e. they
should
attend board of dirs meetings with reasonable regularity) .
iiii) Inquiry--a dir has a duty to inquire when circumstances
would alert a
reasonable person for the need of inquiry.
iiiii) Action--where wrongdoing is revealed, a dir should
object, correct,
or resign. Object to the course of conduct, steer toward correction,
and resign
if it isn’t corrected.
2) Extent of liability--dirs are personally liable for
corporate losses
directly resulting from their breach of duty or negligence in falling
to
discover wrongdoing. a director may seek to avoid being held personally
liable
for acts of the board by recording his dissent.
I) Many statutes permit the articles to abolish or limit
dir’s liability for
breach of the duty of care absent bad faith, intentional misconduct, or
knowing
violation of law.
3) Defenses to liability--these include good faith reliance on
management or
expert’s reports. Disabilities may be considered in
determining whether the dir
has met the standard of care.
c) Duty of Loyalty--a catch-all duty
designed to prevent
unfairness--the duty to act in good faith (BJR applies) . Application:
1)
Self-dealing transactions I) Common Law: (1) early absolute prohibition
against
self-dealing renders transactions void or voidable; (2) permissive
self-dealing: dirs and officers may contract with the corp if (a) done
in
“strictest good faith.” ; (b) with full disclosure;
and (c) consent of “all
concerned.” [1]--burden of proof is on the dir to establish
good faith, honesty
& fairness; [2]--courts weigh self-dealing transactions with
“closest
scrutiny” (3) self-dealing prohibition also applies to
intercorporate
transactions where dirs are common.
ii) Statutory (example) : (1) quasi-safe harbor approach (Iowa
statute)
--transaction is not void or voidable because of dirs’
interest, if either:
[1]--interest is disclosed and approval is made without
counting the vote of
the interested dir.
[2]--interest is disclosed to shs and shs authorise
[3]--transaction is fair
and reasonable (2) Note--dir must still establish that he acted in good
faith,
honesty, and fairness 2) Domination of subsidiary by parent--courts
look at the
transaction to see if self-dealing has occurred. Example (Sinclair Oil)
: I)
declaration of dividends shared pro rata was NOT self-dealing; BJR
applies ii)
contract between parent and sub was self-dealing; apply intrinsic
fairness test
3) Manager’s compensation: I) Ordinary
corporations--conflicts are inevitable
but all firms need to set compensation. The burden of proof is placed
on
challengers as a matter of convenience.
ii) Close corporations--the income generated by the firm may
be diverted to
salaries, so there is an option for self-dealing by the parties in
control to
take tax-advantaged compensation in the form of salaries (taxed once)
as
opposed to dividends (taxed twice) .
d) Statutory Duties and Liabilities--in
addition to general duty of
care, federal and state laws also impose certain duties and
liabilities, e. g.,
registration requirements under the Securities Act of 1933, liability
for rule
10b-5 violations, liability for illegal dividends. Some statutes also
impose
criminal liability on corporate managers for unlawful corporate
actions.
C. OFFICERS
1. ELECTION--officers are usually elected
by the board of dirs. Some
statutes permit election of officers by shs.
2. AUTHORITY OF CORPORATE OFFICERS
(liability of corp to outsiders)
--only authorised officers can bind the corp. Authority may be: actual
(expressed in bylaws or by valid board resolution) , apparent
(corp
gives third parties reason to believe authority exists) , or power
of
position (inherent to position) . If ratified
by the board, even
unauthorised acts can bind the corp.
a) Authority of President--the majority
rule is that the president
has the power to bind the corp in transactions arising in regular
course of
business. 3. DUTIES OF CORPORATE OFFICERS--the duty of care
owed by a
officer is similar to that owed by dirs (and sometimes higher) .
D. CONFLICTS OF INTEREST IN CORPORATE
TRANSACTIONS.
1. DUTY OF LOYALTY--because of their
fiduciary relationship with the
corp, officers and dirs have the duty to promote the interests of the
corp without
regard for personal gain.
2. BUSINESS DEALINGS WITH THE CORPORATION--conflict
of interest
issues arise when a corp transacts business with one of its officers or
dirs,
or with a company in which an officer or dir is financially interested.
a) Effect of Self-Interest on Right to Participate in
Meeting--most
statutes permit an “interested” dir to be counted
toward quorum, and interested
dir’s transactions are NOT automatically voidable by the corp
because the
interested dir’s vote was necessary for approval.
b) Voidability Because of Director’s
Self-Interest--today, such
transactions are voidable only if unfair to the
corporation. The burden
of establishing fairness is on the interested director. Note that a
dir’s
failure to fully disclose material facts may be per
se unfair.
1) Unanimous shareholder ratification--if, after full
disclosure,
shareholder ratification is unanimous, the corp will be estopped from
challenging the transaction with the interested dir (except at to
creditors) .
I) Less-than-unanimous ratification--courts then will look at
whether the
majority shares were owned or controlled by the interested director.
Courts are
more likely to uphold ratification by a disinterested majority so as to
preclude the transaction from being attacked by the corp or by a sh in
a
derivative suit.
2) Statutes--most statutes provide that such transactions are
NOT voidable
if: (1) approved, after full disclosure, by a disinterested board
majority or
by majority of shs, or (2) the transaction is fair
to the corp
notwithstanding disclosure.
I) ” Interested” --an
“interested” dir or officer is one who has a
business,
financial, or familial relationship with a party to the transaction
that would
reasonably affect the person’s judgement so as to adversely
affect the corp.
c) Remedies--the corp may rescind, or
affirm and sue for damages.
3. INTERLOCKING DIRECTORATES--generally,
transactions between corps
with common dirs are subject to the same rules of interested director
transactions. There is no conflict of interest if one corp is the
wholly owned
subsidiary of the other. However, a question of fairness arises where
the
parent owns only a majority of the subsidiary’s shares.
4. CORPORATE OPPORTUNITY DOCTRINE (Also see
duty of loyalty) a)
Definition--COD bars dirs from taking any business
opportunity belonging to
the corp without first offering it to the corp.. If the corp is unwilling
to pursue an opportunity (after an independent board is fully informed
of the
opportunity) , then the dir may pursue it.
b) Defenses (available in most, but not all
jurisdictions) : 1)
Inability--If the corp is legally or financially unable to
take the
opportunity, then the dir generally may take advantage of it. (But the
question
of who caused the financial inability is quite relevant. Example:
Irving Trust
Co--the defense of inability was rejected) .
2) Rejection, abandonment, or approval--then the fiduciary has
a valid
defense.
c) Remedies--constructive trust or
damages--the fiduciary must
account to the firm for all the profits he has made as a result of
usurpation.
d) Definition of a Corporate Opportunity:
1) Line of business
test--does the firm have fundamental knowledge, practical experience,
and
ability to pursue the opportunity? If yes, then it is within the
firm’s line of
business. It should be a natural fit, and not a mere desire by a firm
to pursue
the opportunity.
2) Interest/expectancy test e) Application--Guth
Rule and Corollary:
1) Guth rule (offered in corporate capacity) --if
there is presented to
O/D a business opportunity which the corp is (1) financially able to
undertake,
which is from its nature (2a) in the line of business and is of
practical
advantage to it OR (2b) is one in which the corp has an interest or
reasonable
expectancy (under an established corporate policy or plan) , and, (3)
by
embracing the opportunity the self-interest of the dir will be brought
into
conflict with that of his corp, then officer or dir may NOT take the
opportunity.
2) Guth corollary (a safe harbor; satisfy all provisions and
dir can take)
--if a business opportunity (1) comes to O/D in his individual
capacity
and (2) is not essential to the corp and is (3) one in which corp has
no
interest or expectancy, then the O/D can treat it as his own, IF he has
not
taken corporate resources to pursue the opportunity.
I) ” Essential” --indispensably necessary
to the continued viability of the
firm; ii) Individual or corporate? Look at O/D capacity to determine
how offer
was made 5. COMPETING WITH CORPORATION--such
competition by a dir or
officer may be a breach of fiduciary duty even when the competing
business is not
a corporate opportunity 6. COMPENSATION FOR SERVICES TO THE
CORPORATION--the
compensation plan must be duly authorized by the board, and its terms
must be
reasonable. Good faith and the BJR ordinarily protect disinterested
dirs from
liability to the corp for approving compensation.
a) Publicly Held Corporations--The SEC has
authorised shs to make
proposals about executive pay in management’s proxy
statements. Further, the tax
code now limits expense deductions for executive pay over $1mln, unless
it is
tied to the corp’s performance.
b) Past and Future Services--compensation
for past services is
generally invalid. Compensation for future services
is proper if there
is reasonable assurance that the corp will receive the benefit of the
services.
VI. INSIDER TRADING--purchase or
sale of securities by someone
with access to material non-public information. It may be illegal. It
affects
corps with more than $1 mln in total assets and with at least 500/750
shs.
a) Who may be hurt by insider trading:
1) Target shareholders--they sell too early; 2) Other
arbitrageurs--they
lose a portion of the gain that they make from honest effort 3) Other
issuers--they lose confidence in the stock market 4) The acquiring
company--insider trading drives up their cost of acquisition, since the
target
may adopt defensive measures otherwise not in place.
b) Possible Sources of Liability: 1) Common
Law; 2) 10b-5
traditional; 3) 10b-5 misappropriation theory (O’Hagan) ; 4)
Mail or wire
fraud; 5) 14e-3; 6) Statutory liability under 16(b) --insiders are
forced to
give their profits to the corp, if the y buy and sell securities within
a
6-month period regardless of whether they are using
insider info. (Need
to know 2,3,6) c) O’Hagan--insider
trading violation where a partner in
law firm took info rom his firm regarding the firm’s
client’s plans for
acquisition of Pillsbury and used that info to buy shares in Pillsbury d)
Penalties For Insider Trading--ITSA (Insider Trading
Sanctions Act) --3
measures: 1) Out-of-pocket measure--if a sh buys a share for $10, while
in fact
it costs $9, his out-of-pocket expense is $1.
2) Causation-in-fact--because an insider engaged in insider
trading, it
caused a loss 3) Disgorgement--we look at D’s profit. ITSA
measures the damage
to sh by the amount of profit that D received from the transaction.
2) SEC civil penalties--treble damages; SEC may seek penalty
capped by three
times profit gained or loss avoided.
A. COMMON LAW--under the majority rule,
there was no duty to
disclose to the shs inside info affecting the value of shares.
Therefore, the
protection of investors was very weak.
a) For lability to exist there should be:
1) At least fraud or deceit
upon purchasers; 2) May also be a device or scheme; 3) May also be an
implied
misrepresentation.
b) Two Elements (relationship and unfairness) :
1) Relationship--existence of a relationship giving access,
directly or
indirectly, to information intended to be available for a corporate
purpose and
no other.
I) Insiders include at least officers, dirs, controlling shs
(In re Cady
Roberts) ii) Persons charged with confidentiality by contractual or
fiduciary
relationship 2) Unfairness--inherent unfairness that results when a
party takes
advantage of such information knowing it is unavailable to person with
whom he
is dealing.
B. SECURITIES EXCHANGE ACT OF 1934--IN GENERAL--the
act superseded
common law. Section 12 of the Act requires registration
of any security
traded on a national exchange, or any equity security (held by 500 or
more
persons) of a corp with assets exceeding $5 million.
C. SECTION 10(B) AND RULE 10B-5--section
10(b) prohibits any
manipulation or deception in the purchase or sale of any security,
whether or not
it’s registered. Rule 10b-5 prohibits the use of the mails or
other
instrumentality of interstate commerce to defraud, misrepresent, or
omit a
material fact in connection with a purchase or sale of any
security.
1. COVERED CONDUCT--rule 10b-5 applies to nondisclosure
by
dirs or officers, as well as to misrepresentations.
It applies not only
to insider trading but also to any person who makes
a misrepresentation
in connection with a purchase or sale of stock.
2. COVERED SECURITIES--rule 10b-5 applies
to the purchase or sale of any
security, registered or unregistered. a jurisdictional limitation
requires that
the violation must involve the use of some instrumentality of
interstate
commerce.
3. WHO CAN BRING SUIT UNDER 10B-5--private
plaintiffs and the SEC.
Private plaintiffs must be either purchasers or sellers of security.
4. MATERIALITY--for rule 10b-5 to apply,
the information
misrepresented or omitted must be material (i. e., a reasonable sh
would
consider it important in deciding whether to buy or to sell) .
5. FAULT REQUIRED (SCIENTER) --a defendant
is not liable under rule
10b-5 if he was without fault or merely negligent. The scienter
requirement is
satisfied by recklessness or an intent to deceive,
mislead, or convey a
false impression. Scienter is also required for injunctive relief.
a) Recklessness Defined: 1) D knew the
hazard and proceeded
nonetheless (subjective test) ; 2) D proceeded despite what a
reasonable person
would perceive (objective test) ; b) Recklessness Under PSLRA:
1) Knowing
conduct-- yields jointly and severally liable; 2) Non-knowing conduct
(e. g.,
recklessness) --yields fair share (proportionate liability) , found in
accordance with special interrogatories.
6. CAUSATION AND RELIANCE--a plaintiff must
prove that violation
caused a loss (i. e., he must establish reliance on the wrongful
statement or
omission) . However, in omission cases, there is a
rebuttable
presumption of reliance once materiality is established.
a) Fraud On The Market--where securities
are traded on a
well-developed market (rather than in a face-to-face transaction) ,
reliance on
a misrepresentation may be shown by alleging
reliance on the integrity
of the market.
b) Face-to-Face Misrepresentations--a
plaintiff can show actual
reliance in these cases by showing that the misrepresentation was
material,
testifying that he relied upon it, and showing that he traded soon
after
misrepresentation.
7. WHEN NONDISCLOSURE CONSTITUTES a VIOLATION
a) Mere Possession of Material Information--generally,
nondisclosure
of material, non-public information violates rule 10b-5 only
when there
is a duty to disclose independent of rule 10b-5 b) Insider
Trading--insiders
(dirs, officers, controlling shs and corporate employees) violate rule
10b-5 by
trading on the basis of material, non-public info obtained through
their
positions. They have a duty to disclose before trading.
c) Misappropriation--the liability of
noninsiders who wrongfully
acquire (misappropriate) material non-public info has not been ruled
upon by
the US Supreme Court, although some lower level federal courts have
imposed
criminal liability.
1) Duty to Employer--using the misappropriation theory, criminal
liability under rule 10b-5 has been imposed where an employee
trades on
info used in violation of the employee’s fiduciary duty to
his employer. An
employee’s duty to “abstain or disclose”
with respect to his ER does NOT extend
to the general public. However, the Insider Trading and Securities
Fraud
Enforcement Act of 1988 makes any person who violates rule 10b-5 by
trading
while in possession of material, non-public info liable to any
person
who, contemporaneously to the transaction, purchased or sold securities
of the
same class. Liability is limited to the defendant’s profit or
avoided loss.
2) Mail and wire fraud--the application of the federal mail
and wire fraud
statute to this situation lessens the importance of the
misappropriation theory
in imposing criminal liability under rule 10b-5.
3) Special rule for tender offers--once substantial steps
toward making a
tender offer have begun, it is a fraudulent, deceptive, or manipulative
act for
a person possessing material information about the tender offer to
purchase or
sell any of the target’s stock, if that person knows that the
info is nonpublic
and has been acquired from the bidder, the target, or someone acting on
the
bidder’s or the target’s behalf.
d) ” Disclose or Abstain” --nondisclosure
by a person with a duty to
disclose violates rule 10b-5 only if he trades
(Cady rule) 8.
LIABILITY OF NONTRADING PERSONS FOR MISREPRESENTATION--a
nontrading corp or
person who makes a misrepresentation that could cause reasonable
investors to
rely thereon in the purchase or sale of securities is liable under rule
10b-5,
provided the scienter requirement is satisfied.
9. LIABILITY OF NONTRADING CORPORATION
FOR NONDISCLOSURE--the
basic principle is “disclose or abstain.” Thus, a
nontrading corp is generally
not liable under rule 10b-5 for nondisclosure of material facts.
a) Exceptions--a corp has a duty to: 1)
Correct misleading statements
(even if unintentional) ; 2) Update statements that have become
materially
misleading by subsequent events; 3) Correct material errors in
statements by
others (e. g, analyst’s report) about the corp, but only if
the corp was involved
in the preparation of the statements; and 4) Correct inaccurate rumors
resulting from leaks by the corp or its agents.
10. TIPPEE AND TIPPER LIABILITY--a person,
not an insider, who trades
on info received from an insider is a tippee and may be liable under
rule 10b-5
if he received info through an insider who breached fiduciary duty in
giving
the info, AND the tippee knew or should have known of the breach
(Dirks) a)
Breach of Insider’s Fiduciary Duty--whether an
insider’s fiduciary duty was
breached depends largely on whether the insider communicated the info
to
realize the gain or advantage. Accordingly, tips to friends or
relatives and
tips that are a quid pro quo for a past or future benefit from the
tippee
result in fiduciary breach. Note that if a tippee is liable, so is the
tipper.
11.” TEMPORARY INSIDERS” --corporate
info legitimately revealed to a
professional or consultant (e. g., accountant) working for the corp may
make
this person a fiduciary of corp 12. AIDERS AND ABETTORS--liability
cannot
be imposed solely because a person aided and abetted the violation of
the rule.
13. APPLICATION OF RULE 10B-5 TO BREACH OF FIDUCIARY
DUTY BY DIRECTORS,
OFFICERS, AND CONTROLLING SHAREHOLDERS.
a) Ordinary Mismanagement--a breach of
fiduciary duty not involving
misrepresentation, nondisclosure, or manipulation does NOT violate rule
10b-5; b)
Misrepresentation or Nondisclosure--if this is the basis of a
purchase from
or sale to the corp by a dir or officer, the corp can sue the fiduciary
under
rule 10b-5 and also for breach of fiduciary duty.
If the corp doesn’t
sue, a minority sh can maintain a derivative suit
on the corporations
behalf.
c) Purchase or Sale By Controlling Shareholder--when
a corp purchases
stock from or sells stock to a controlling sh at an unfair price, and
material
facts aren’t disclosed to minority shs, a derivative action
may lie if the
nondisclosure caused a loss to the minority shs.
The plaintiffs must
establish causation by showing that an effective
state remedy (e. g.,
injunction) was foregone because of nondisclosure.
14. BLUE CHIP RULE--PRIVATE PLAINTIFF--a
plaintiff can bring a
private cause of action only if he actually purchased or sold the
relevant
securities. “Sale” includes an exchange of stock
for assets, mergers and liquidations,
contracts to sell stock, and pledges. The SEC can bring action under
rule 10b-5
even though it has neither purchased or sold securities.
15. DEFENSES
a) Due Diligence--if a
plaintiff’s reliance on a misrepresentation or
omitted fact could have been prevented by his exercise of due
diligence,
recovery may be barred. Mere negligence does NOT constitute a lack of
due
diligence, although a plaintiff’s intentional misconduct and
his own
recklessness (if D was merely reckless) will bar recovery.
b) In pari delicto--a private suit for
damages under rule 10b-5 will
be barred if: 1) The plaintiff bears substantially equal
responsibility for
the violations, AND 2) Preclusion of the suit would not significantly
interfere with the enforcement of securities law.
16. REMEDIES
a) Out-of-pocket Damages--this is the
difference between the price
paid for stock and its actual value.
1) Compare--benefit-of-the-bargain damages--these are measured
by the value
of the stock as it really is and the value it would have had if a
misrepresentation had been true.
2) Standard measure of conventional damages--out-of-pocket
damages is the
standard measure in private actions under rule 10b-5;
benefit-of-the-bargain
damages are usually not granted.
b) Restitutionary Relief--this may be
sought instead of conventional
damages: 1) Rescission--returns the parties to their status quo before
the
transaction 2) Rescissionary or Restitutionary damages--money
equivalent of
rescission 3) Difference between conventional damages and
Restitutionary
relief--out-of-pocket damages are based on the P’s loss,
while Restitutionary
relief is based on the D’s wrongful gain. Rescission or
Rescissionary damages
may be attractive remedies when the value of the stock changed
radically after
the transaction. However, Restitutionary relief is usually unavailable
in cases
involving publicly held stock.
c) Remedies Available to the Government--although
the SEC cannot sue
for damages, it can pursue several remedies including special monetary
remedies: 1) Injunctive Relief--the SEC often seeks injunctive relief
accompanied with a request for disgorgement of profits or other
payments that
can be subject to criminal sanctions (fines and
jail sentences) and civil
penalties (up to three times the profit gained or loss
avoided) .
17. JURISDICTION, VENUE, AND SERVICE OF PROCESS--suits
under 10b-5
are based on the 1934 Act, and exclusive jurisdiction is in the federal
district courts. State claims arising out of the same transactions may
be
joined with the federal claim under the supplemental jurisdiction
doctrine.
Venue can be wherever any act or transaction constituting a violation
occurred,
or where the D is found or transacts business. Process can be served
where the
D can be found or where he lives.
18. STATUTE OF LIMITATIONS--the 1934 Act
contains no SOL; however,
the SCt has held that private actions must be
brought within one year
after discovery of the relevant facts and within three
years
following accrual of the cause of action. The tolling doctrine is
inapplicable.
a) Exceptions--the time limitations
don’t apply to all rule 10b-5
private actions, e. g., SEC limitations period of five years for
private suits
by contemporaneous traders against purchasers or sellers who violate
rules
regarding trades while in possession of material, non-public
information.
Further, the SEC is not subject to any limitations period in civil
enforcement actions.
D. SECTION 16 OF THE 1934 ACT--Section 16
concerns purchases followed
by sales, or sales followed by purchases, by certain insiders, within a
six-month period.
1. FIRMS AND SECURITIES AFFECTED UNDER SECTION 16--Section
16 applies
to those firms and securities that must be registered under section 12
of the
1934 act.
a) Reason--16(a) references registered
securities under S12; S12(a)
and 12(g) create the registration requirement for securities; S12(g)
creates an
asset ($1 mln total) and distribution (500 to 700 depending on timing)
; 16(b)
references “such” officers, etc., which refers to
sub(a) b) Note--trading
in all of a corp’s equity securities is
subject to section 16 if any
class of its securities is registered under section 12.
2. DISCLOSURE REQUIREMENT--Section 16(a)
requires every beneficial
owner of more than 10% of the registered
stock and directors and
officers of the issuing corp to file periodic reports with
the SEC showing
their holdings and any changes in their holdings.
a) Who is an Officer (16a-1f) --issuer’s
president, principal
financial director, principal accounting officer, any vice-president of
the
issuer in charge of a principal business unit, any other officer who
performs
similar policy-making functions for the issuer.
3. LIABILITY--to prevent the unfair use of
information, section 16(b)
allows a corp to recover profits made by an officer, dir, or
more-than-10%
beneficial owner on the purchase and sale or sale
and purchase of its
securities within a six-month period.
a) Coverage--Section 16(b) does NOT cover
all insider trading and is
NOT limited to trades based on inside info. The critical element is
short-swing
trading by officers, dirs, and more-than-10% beneficial owners.
1) Note--beneficial owner must own 10% or more BOTH at he time
of sale and
purchase to be liable under 16(b) .
b) Calculation of short-swing profit--the
profit recoverable is the
difference between the price of the stock sold and the price of the
stock
purchased within six month before or after the
sale.
1) Multiple transactions--if there is more than one purchase
or sale
transaction within the six-month period, the transactions are paired by
matching the highest sale price with the lowest purchase price, the
next
highest price with the next lowest price, etc. a court can look six
month
forward or backward from any sale to find a purchase, or from any
purchase to find
a sale c) Who May Recover--the profit belongs to
the corp alone.
Although not a typical derivative action, if the corp fails to sue
after a
demand by a sh, the sh may sue on the corp’s behalf. The
cause of action is
federal, so there is no posting of security requirement, and no
contemporaneous
sh requirement. Remedy: 1) All sales and purchases within 6 months are
included; 2) Damages calculated as to maximise the gain to he company;
3) Match
highest sale price against lowest purchase price within relevant
period;
continue until you can go no further.
d) Insiders--insiders are officers (named
officers and those persons
functioning as officers) , dirs (actually serving or who authorised
deputization of another) , and beneficial owners of more than 10% of
the
shares. Insider status for officers and dirs is determined at the time
they
made a purchase or sale. Transactions made before taking office is NOT
within
section 16(b) , but those made after leaving office are subject to the
statute
if they can be matched with a transaction made while in office.
Liability is
imposed on a beneficial owner only if he owned more than 10% of the
shares at
the time of both the purchase and sale.
e) ” Purchase or Sale” --this
includes any purchase of stock.
Unorthodox transactions that result in the acquisition or deposition of
stock
(e. g., merger for stock, redemption of stock) are also purchases and
sales.
E. SECTION 16(B) COMPARED TO RULE 10B-5:
a) Covered Securities--Section 16(b)
applies to securities registered
under the 1934 act; rule 10b-5 applies to all
securities.
b) Inside Information--Section 16(b) allows
recovery for short-swing
profits regardless of whether they are attributable
to
misrepresentations or inside info; rule 10b-5 recovery is available only
where there was a misrepresentation or a trade based on inside info.
c) Plaintiff--recovery under section 16(b)
belongs to the corp, while
rule 10b-5 recovery belongs to the injured purchaser or seller.
d) Overlapping Liability--it is possible
that insiders who make
short-swing profits by use of inside info could be liable under both
section
16(b) and rule 10b-5.
F. COMMON LAW LIABILITY FOR INSIDER TRADING--insider
trading
constitutes breach of fiduciary duties owed to the corp, so the corp
can
recover profits made from insider trading a) Common Law
Liability Compared
To Section 16(b) Liability--both common law and section 16(b)
liability run
against insiders and in favour of the corp. However, unlike section
16(b) , the
common law theory applies to all corps (not just
those with registered
securities) , recovery can be had against any
corporate insider, the
purchase and sale is NOT limited by a six-month period, and the
transaction must
be based on the inside info.
b) Common Law Liability Compared to Rule 10b-5
Liability--the
theories of recovery are similar except that under the common law
recovery runs
to the corp (not to the injured purchaser or seller) , there is no
purchaser or
seller requirement, and noninsiders (tippees) have not yet been held
liable.
VII. RIGHTS OF SHAREHOLDERS
A. VOTING RIGHTS
1. RIGHT TO VOTE IN GENERAL--shs may
generally vote for the election
and removal of dirs, to amend the articles or bylaws, and on major
corporate
action or fundamental changes.
a) Who May Vote--the right to vote is held
by shs of record as of the
record date; b) Restrictions on Right--shares may
be either voting or
nonvoting, or have multiple votes per share.
2. SHAREHOLDER MEETINGS--generally, shs can
act only at meetings duly
called and noticed at which a quorum is present.
a) Compare--informal action--statutes
permit sh action without a
meeting if there is unanimous written consent of all shs entitled to
vote.
3. SHAREHOLDER VOTING
a) Straight Voting--this system of voting
allows one vote for each
share held and applies to all matters other than director
elections, which
may be subject to cumulative voting. Certain fundamental changes (e.
g.,
merger) frequently require higher shareholder approval.
b) Cumulative Voting For Director--this
system allows each share
one vote for each director to be elected, and the votes may
be cast all for
one candidate or divided among candidates as the sh chooses, thereby
helping
minority shs to elect a dir. Cumulative voting may be mandatory or
permissive.
4. VOTING BY PROXY--a proxy authorises
another person to vote a
shareholder’s shares. The proxy usually must be in
writing, and its
effective period is statutorily limited unless it is validly
irrevocable.
a) Revocability--a proxy is normally
revocable by the sh at any time,
although it may be made irrevocable if expressly
stated and coupled
with an interest in the shares themselves. Absent written
notice to the
corp, the death or incapacity of a sh does NOT revoke a proxy. a sh may
revoke
a proxy by notifying the proxy holder, giving a new proxy to someone
else, or
by personally attending the meeting and voting.
b) Proxy Solicitation--almost all shs of
publicly held corps vote by
proxy. Solicitations of proxies are regulated by the Securities
Exchanges Act
of 1934 Section 14a, federal proxy rules and, in some cases, state law.
Federal
proxy rules apply to the solicitation of all proxies of registered
securities,
but NOT to nonmanagement solicitation of 10 or fewer shs. The term
“solicitation” is broadly interpreted by the SEC to
include any part of a plan
leading to a formal solicitation, e. g., inspection of shareholder
list.
1) 1992 amendments--the SEC revised the proxy rules to make it
easier for
shs to communicate with each other. Significant changes include: a safe
harbour
for communications that don’t involve solicitation of voting
authority,
relaxation of requirements involving broadcast of published
communications,
relaxed preliminary filing requirements for solicitations, and removing
communications between shs concerning proxy voting from definition of
“solicitation.” 2) Requirement of Full
Disclosure--the proxy rules require full
and accurate disclosure of all pertinent facts and the identities of
all proxy
participants, disclosure of compensation paid to certain officers and
dirs, and
disclosure of conflict-of-interest transactions involving more than
$60,000.
3) Inclusion of Shareholder Proposal--shareholder proposals
must be included
in corporate proxy materials if the proponent is a record owner or
beneficial
owner of at least 1% or $1000 worth of securities entitled to vote on
the
matter. The proposal must not exceed 500 words.
I) Exceptions--a proposal need NOT be included if it: is not a
proper
subject for shareholder action, would be illegal, is false or
misleading, seeks
redress of a personal claim, relates to operations accounting to less
than 5%
of the corp’s total assets and is not otherwise related to
the corp’s business,
concerns a matter beyond the corp’s power to effectuate,
relates to ordinary
business operations, relates to an election to office, is counter to a
proposal
submitted by the corp at the same meeting, is moot or duplicate, deals
with the
same subject matter as a very unsuccessful prior proposal, or relates
to
specific amounts of cash or stock dividends.
ii) Private right of action--a private right of action is
available to a sh
whose proposal was rejected by the corp on the ground that it fails
within one
of the exceptions.
iii) Providing shareholder lists--a sh has a right to obtain a
list of shs
or to have his communication included with the corporate proxy
materials.
4) Remedies for violation of proxy rules--these include suit
by the SEC to
enjoin violations or to set aside an election and individual suits,
class
actions, or derivative suits by the shs (In a private suit, the P must
show materiality
and causation, but causation is normally presumed from
materiality.
Fairness to the corp is NOT a defense to a violation of proxy rules) .
The
court may rescind corporate action resulting from a misleading proxy
solicitation or award damages.
c) Expenses Incurred In Proxy Contests--corporate
funds may be used
by management with respect to reasonable proxy solicitation expenses
incurred
in order to obtain a quorum for the annual meeting or regarding
controversy
over corporate policy (as opposed to a personnel controversy) . The
corp may,
with sh approval, voluntarily pay the reasonable
expenses to insurgents
who win a proxy contest involving policy.
5. OTHER METHODS TO COMBINE VOTES FOR CONTROL (CLOSE
CORPORATIONS)
--other methods include shareholder voting agreements which
may be enforced
by specific performance, agreements regarding greater-than-majority
approval,
shareholder agreements binding the discretion of dirs, and voting
trusts.
B. RESTRICTIONS ON TRANSFER OF SHARES--although
most
frequently used in close corps, stock transfer restrictions may also be
imposed
by larger corps (e. g., to restrict ownership to employees) . The two
most
common types of restriction are a right of first refusal
and a mandatory
sell-buy provision. Restrictions must be reasonable and will
be strictly
construed.
a) Notice Requirements--a lawful stock
transfer restriction is of no
effect unless noted conspicuously on the stock
certificate. If there is
no such notice, an innocent transferee is entitled ti have the shares
transferred to him.
C. SHAREHOLDERS’ INFORMATIONAL RIGHTS:
1. TYPES OF BOOKS AND
RECORDS--these include shareholder lists, minutes, financial
records, and
business documents.
2. COMMON LAW--at CL, a sh has a right to
inspect records for proper
purpose.
3. STATUTES--statutes govern these rights
in most states. Many
statutes apply only to certain shs but are usually interpreted to
supplement
the common law. Most statutes preserve the proper purpose test, but
place the
burden on the corp to prove improper purpose.
4. PROPER VERSUS IMPROPER PURPOSES--the
test is whether the sh is
seeking to protect the sh interest. Multiple
purposes that include a
proper one usually will not preclude inspection. Generally, a sh can
inspect
the sh list because it is often necessary to the exercise of other
rights like
proxy fights, sh litigation, etc. Inspection of a sh list for proxy
contest is
a proper purpose. However, it has been held that corporate records
cannot be
examined solely for the purpose of advancing political and social views
or to
aid a sh as a litigant on a personal, non-shareholder claim.
5. COMPARE--MANDATORY DISCLOSURE OF INFORMATION--a
sh’s inspection
right is separate and distinct from the statutory requirements
governing the
affirmative disclosure of certain information by corps (e. g., Section
12 of
Securities Exchange Act of 1934, proxy rules, state statutes) .
D. FIDUCIARY OBLIGATIONS OF CONTROLLING
SHAREHOLDERS--a controlling
sh owes a fiduciary duty in his business dealings with the
corp, in
taking advantage of corp opportunities (rules more lenient than those
applied
to dirs and officers) , and in causing fundamental changes.
1. ACTIONS ENTIRELY IN SHAREHOLDER CAPACITY--a
controlling sh must
NOT act to benefit himself at the expense of the minority shs; i. e.,
in a
transaction where control of the corp is material, he must act with
good faith
and inherent fairness toward the minority.
2. OBLIGATIONS OF SHAREHOLDERS IN CLOSE CORPORATIONS--both
majority
and minority shs owe each other an even stricter duty (utmost good
faith and
loyalty) than is owed by controlling shs in publicly held corps. This
duty has
been interpreted to mean that there must be equal treatment of
all shs,
i. e., they must be afforded equal opportunities.
3. DISCLOSURE--a controlling sh must make
full disclosure when
dealing with minority shs.
4. SALE OF CONTROL--in most jurisdictions,
a controlling sh is
permitted to sell his stock at a premium, i. e, a price not available
to other
shs. Exceptions to these rule include a bare sale of office (invalid) ,
the
corporate action theory, sales involving fraud or nondisclosure, and
knowing
sales to transferees who plan to loot or deal unfairly with the corp.
E. SHAREHOLDER SUITS
1. DIRECT (INDIVIDUAL) SUITS--a direct suit
may be brought by a sh on
his own behalf for injuries to sh interests. If the injury
affects a number
of shs, the suit may be brought as a class action.
2. DERIVATIVE SUITS--if a duty owed to the
corp has been abridged,
suit may be brought by a sh on behalf of the corp.
a) Distinguish Direct From Derivative Suits--the
test is whether the
injury was suffered by the corp directly or by the sh, and to whom the
D’s duty
was owed 1) Close corporations--in some cases, minority shs have been
allowed
to bring a direct action against controlling shs for breach of
fiduciary duty b)
Prerequisite to Suit--Exhaustion of Corporate Remedies--the
P-sh must
specifically plead and prove that he exhausted his remedies within the
corporate structure 1) Demand on directors--the P-sh must make a demand
on the
dirs to remedy the wrong, unless such demand would have been futile.
Note that
in the absence of negligence, self-interest, or bias, the fact that a
majority
of dirs approved the transaction does NOT itself excuse the demand.
I) Model statutes--under both model statutes, demand should be
excused only
if it is shown that irreparable injury to the corp would result; ii)
Effect of
rejection of demand--if the matter complained of does not involve
wrongdoing by
the dirs, the board’s good faith refusal to sue bars the
action, unless the
P-sh can raise a reasonable doubt that the board exercised reasonable
business
judgement in declining to sue. If the suit alleges wrongdoing by a
majority of
dirs, the board’s decision not to sue will NOT prevent the
derivative suit.
2) Demand on shareholders--in most states, the p-sh must also
make a demand
on shs unless excused (e. g., the alleged wrongdoing is beyond the
power of the
shs to ratify) . Where demand on shs is required, a good faith refusal
to sue
by the majority of disinterested shs will preclude the suit.
c) Qualifications of Plaintiff--a few
states require the P to be a
registered sh; most states also allow a beneficial owner of shares to
bring
suit. Also, a sh of a parent corp can bring a derivative suit on a
subsidiary’s
cause of action. Shs cannot complain of wrongs committed before they
purchased
their shares except: 1) where the P acquires shares by operation of
law; 2) in
section 16(b) violations; 3) where serious injustice will result; 4)
where the
wrong is continuing in nature.
The P must fairly and adequately represent the interests of
all shs d)
Securities For Expenses--in a number of states, the P, under
certain
circumstances, must post a bond to indemnify the corp against certain
of its
litigation expenses, including attorney’s fees, in the event
the P loses the
suit. a p-sh who loses may also be liable for the court costs incurred
by the
parties.
e) Defenses--defenses to derivative suit
include the SOL and
equitable defenses (laches, unclean hands, etc) ; f)
Settlement And Recovery--any
settlement or judgement belongs to the corp, absent special
circumstances.
Settlement or dismissal of the suit is generally subject to court
approval
after notice to all shs.
g) Reimbursement to Plaintiff--a victorious
plaintiff may be entitled
to reimbursement from the corp for litigation expenses; h)
Indemnification
of Officers And Directors--indemnification issues arise when
officers and
dirs are sued for conduct undertaken in their official capacity. If the
officer
or dir wins on the merits, he may be indemnified. Most statutes also
authorise
the corp to advance (not pay) expenses in defending against the claim.
Statutes
vary where the officer or dir settles or loses; they are most liberal
concerning indemnification in a third-party suit as opposed to a
derivative
suit.
I) Liability Insurance--in most states, a
corp can obtain liability
insurance for its indemnification costs and for any liability incurred
by its
officers in serving the corporation.
Не подходит? Заказать реферат нашим авторам? Вы также можете добавить свой реферат
Реферат прочитали 623 чел.