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BUSINESS ASSOCIATIONS

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 shs liability is limited to their investment;

c)Free Transferability of Interest--shares, representing ownership interests, are freely transferable;

d)Centralized Management and Control--a corps management is centralized in a board of dirs and officers. Shs have no direct control over the boards 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, pships are governed by the Uniform Partnership Act (UPA). However, the Revised UPA (RUPA) has been adopted by a few states

a)Aggregate Status--a pship is an aggregation of two or more persons who are engaged in business as co-owners. Although not a legal entity, a pship is treated as one for certain purposes, e.g., ownership and transfer of property. RUPA confers entity status on pships;

b)Unlimited Liability--every partner is subject to unlimited personal liability on pship debts;

c)Transferability of Interests--a partner cannot make a transferee a member of the pship. She can, however, assign his interest in the pship, thus permitting the assignee to receive distributions of profits. Because the assignee does not become a member of the pship, he is not entitled to participate in pship business or management.

d)Duration and Dissolution--a pship 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--pships can also be dissolved in contravention of the pship agreement, by the express will of any partner, by a court or by a partners conduct. Upon wrongful dissolution, nonbreaching partners may seek damages for breach and, if they choose to do so, may continue the pship 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 pship 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)Autority--each partner, as an agent of the firm, may bind the pship by acts done for the carrying on, in the usual way, the business of the pship.

1)RUPA--a pship is bound by a partners act for carrying on in the usual way either the actual pship business or a business of the kind carried on by the pship.

g)Ownership of Property--title may be held in the name of the pship, but property is owned by the individual partners as tenants in pship. There is no tenancy in pship under RUPA, which provides that property acquired by pship is owned by pship, 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 pship. Partners are jointly and severally liable for wrongful acts and breaches of trust; they are only jointly liable for debts and obligations of the pship.

1)Statutory reforms--many state statutes specifically allow a pship to be sued in its own name. Other states make all pship liabilities joint and several. Other reforms provide that not all joint obligors need to be joined in a suit.

2)RUPA--a pship may sue and be sued in its own name, and partners are jointly and severally liable for all pship obligations. A claim against the pship cannot be satisfied from a partners personal assets unless pship assets have been exhausted.

2.JOINT VENTURE--a pship formed for some limited investment or operation, as opposed to a continued business enterprise. Joint ventures are governed by the rules applicable to pships

3.LIMITED PARTNERSHIP--this is a pship consisting of two classes of partners: general partners (with rights and obligations as in an ordinary pship) 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 pship 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 nonmember managers. Depending on the statute, distributions are made either equally to each member or in proportion to each members contribution.

a)Withdrawal and Dissolution--some statutes provide that any event that terminates a members 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)--its 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)Undercapitalization--if the corp was organized 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 free-standing 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 authorized, address of the corps 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 states 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 organizational 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 authorize 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 organized 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 recognize 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 doesnt 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 its 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 CORPS 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)Corporations 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 corporations 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 principals manifestations of consent to him." Rest §7. Operative word is "manifestation" . If he says, do something, its 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 others 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 doesnt 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 thats missing is the opposite party. So the President of the firms 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 corps 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 nonperforming 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 unauthorized 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 CORPORATIONS BUSINESS--corporate statutes vest the power to manage in the board of directors, except as provided by valid agreement in a close corp. He boards 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 incorpn, 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 authorized 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 authorized 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 Noncompliance 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 authorize 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 judgment (business judgment 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 isnt 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 dirs 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 experts 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 authorize

[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)Managers 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 authorized 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 unauthorized 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 dirs transactions are NOT automatically voidable by the corp because the interested dirs vote was necessary for approval.

b)Voidability Because of Directors 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 dirs 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 persons judgment 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 subsidiarys 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 t ...........