LECTURE HANDOUT

CORPORATIONS

PROFESSOR DOUGLAS K. MOLL

Copyright © 2019 by BARBRI, Inc. CAH

 CORPORATIONS

CORPORATIONS
BY PROFESSOR DOUGLAS MOLL
Six fact patterns: 1. Organization of a corporation
2. Issuance of stock
3. Directors and officers
4. Shareholders
5. Fundamental corporate changes
6. Federal securities

FACT PATTERN 1: ORGANIZATION OF A CORPORATION

I. WHAT DOES IT TAKE TO FORM A CORPORATION?
(PEOPLE, PAPER, ACT)
A. PEOPLE: INCORPORATORS. MUST HAVE ONE OR MORE. WHAT
DOES AN INCORPORATOR DO?

__________________________________________________________

__________________________________________________________

Can XYZ, Inc. serve as an incorporator for Curl Up and Dye Beauty Supply
Corp.? Can Joan Rivers?

__________________________________________________________

B. PAPER: ARTICLES OF INCORPORATION.

1. a. The articles are a contract between the corporation and the

shareholders.

b. And also a contract between the corporation and the state.

2. Information in articles.

a. Names and addresses.

1) Corporate name.

Can I form a corporation with the name Vance

Refrigeration? No. It must include one of these “magic
words” (or an abbreviation):
_________________________________________

_________________________________________
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2) Name and address of each incorporator.

3) Name and address of each initial director.

4) Name of registered agent and address of the

registered office. (Registered agent is the company’s
legal representative, so can receive service of process
for the corporation.)

b. What if there is no statement of the corporation’s duration?

_______________________________________________

_______________________________________________

c. Generally, must have a statement of purpose.

1) Can the articles of Vance Refrigeration, Inc. indicate

that the corporation's purpose is to “engage in all
lawful activity, after first obtaining necessary state
agency approval”? ___________________________

-- In some states, general purpose is presumed and

the articles need not say anything about the
corporation’s purpose.

2) Specific statement of purpose and ultra vires rules.

-- What if the articles of Vance Refrigeration, Inc. say the

corporation will “manufacture refrigeration machinery”
and the corporation then goes into gold mining? Doing
this is an ultra vires activity (it’s beyond the scope of the
articles). At common law, any ultra vires contract could
be voided as beyond the company’s capacity. How do
we handle ultra vires today?

__________________________________________

__________________________________________

__________________________________________

d. Capital structure (stock).

1) Definitions of background terms (to impress friends at

parties)

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Authorized stock–maximum number of shares the

corporation can sell.
Issued stock–number of shares the corporation
actually sells.
Outstanding stock–shares that have been issued and
not reacquired.

2) Articles must include: (a) authorized stock, (b) number

of shares per class, and (c) information on voting
rights and preferences of each class.

C. ACT.

Incorporators have notarized articles delivered to the Secretary of State

and pay required fees. What happens if the Secretary of State’s office
accepts the articles for filing?

__________________________________________________________

-- At that point, we have a de jure corporation.

-- Then, the board of directors holds the organizational meeting, where it

selects officers and adopts any bylaws and conducts other appropriate
business.

II. LEGAL SIGNIFICANCE OF FORMATION OF

CORPORATION
A. Internal affairs of a corporation (e.g., roles and duties of directors, officers, and
shareholders) are governed by law of the state in which the corporation is
formed. Is this true even if the company only does business in Iceland?

__________________________________________________________

__________________________________________________________

B. A corporation is a separate legal person. It can sue and be sued, hold

property, be a partner in a partnership, make charitable contributions, etc. It
is taxed on its profits; in addition, shareholders are taxed on distributions.
So there is “double taxation.”

-- Can we form a corporation and avoid having to pay income tax at the
corporate level?

__________________________________________________________

__________________________________________________________
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An S Corporation has no more than 100 shareholders, all of whom are

human and U.S. citizens or residents. There is only one class of stock and
it is not publicly traded.

C. no
Are the directors or officers liable for what the entity does? ____________
no
Are the shareholders (owners) liable for what the entity does? __________

This is “limited liability,” which means that shareholders generally can only
lose the amount that they invested in the company.

So, generally, who is liable for what the corporation does?

THE CORPORATION ITSELF. THAT IS WHY WE INCORPORATE. OWNERS ARE
__________________________________________________________
NOT PERSONALLY LIABLE.

III. DE FACTO CORPORATION AND CORPORATION BY

ESTOPPEL
The proprietors failed to form a de jure corporation, so they will be personally
liable for what the business does (because it’s just a partnership). Under these
doctrines, the business is treated as a corporation, so shareholders are not liable
for what the business did. Anyone asserting either doctrine must be unaware of
the failure to form a de jure corporation.

A. De facto corporation. Requirements:

1. There is a relevant incorporation statute (there is!).

2. The parties made a good faith, colorable attempt to comply with the
statute.
and
3. Some exercise of corporate privileges (acting like we have a
corporation).

-- If the doctrine applies, the business is treated as a corporation for

all purposes except in an action by the state. (Such an action would
be quo warranto).

-- Incorporators put together the proper documents and mail them to

the secretary of state. Unbeknownst to them, the documents are lost
in the mail. In the meantime, the business is being operated as a
corporation, and enters into a contract. Are the shareholders liable
on the contract?
YES UNLESS THE COURT APPLIES DE FACTO CORPORATION. THEY FAILED TO
__________________________________________________________
FORM A DE JURE CORPORATION. WE SEEM TO MEET THE TEST HERE.

__________________________________________________________

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B. Corporation by estoppel: one who treats a business as a corporation may

be estopped from denying that it is a corporation.

-- You do business with people who hold their business out as a

corporation. They think it’s a corporation. So do you. You write
checks to the “corporation” and deal with it as a corporation. But
there is no corporation. You sue the proprietors individually. Under
this doctrine, you cannot win. You are estopped to deny that the
business was a corporation.

-- It can also prevent the improperly-formed “corporation” from

avoiding liability by saying it was not properly formed.

-- Corporation by estoppel applies only in what kinds of cases?

__________________________________________________________

__________________________________________________________

C. What is the status of these two doctrines?

__________________________________________________________

__________________________________________________________

IV. BYLAWS
A. Are corporations required to have bylaws? _________________________

But we usually have them, for internal governance–e.g., responsibilities of

officers, times and places for regular meetings of the board, methods of
giving notice, etc.

-- Are bylaws filed with the state?

__________________________________________________________

__________________________________________________________

B. Who adopts the initial bylaws?

__________________________________________________________

__________________________________________________________

C. Who can amend or repeal the bylaws of a corporation?

__________________________________________________________

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D. If bylaws conflict with the articles, which controls?

__________________________________________________________

__________________________________________________________

V. PRE-INCORPORATION CONTRACTS
A. A promoter is a person acting on behalf of a corporation not yet formed.
She might enter into a contract on behalf of a corporation not yet formed.

B. Liability of the corporation. The corporation is not liable on pre-

incorporation contracts until it adopts the contract.

On January 10, P, acting as a promoter for a corporation not yet formed,

leases a building from Don Draper and signs the lease "Oscar de la Rental
Cars, Inc." On February 20, Oscar de la Rental Cars, Inc. is formed.

-- Is the corporation liable on the contract? Yes, if it adopted the

contract. How can that happen?

a. Express -- board takes an action adopting the contract (e.g.,

board resolution).

b. Implied --

__________________________________________________________

__________________________________________________________

C. Liability of the promoter. Unless the contract clearly provides otherwise,

the promoter is liable on pre-incorporation contracts until there is a ______.

-- A novation is an agreement of the promoter, the corporation, and

the other contracting party that the corporation will replace the
promoter under the contract.

-- Will P be liable on the lease if Oscar de la Rental Cars, Inc. is never

formed?

__________________________________________________________

-- Will P be liable on the lease if Oscar de la Rental Cars, Inc. is

formed and adopts the lease?

__________________________________________________________

__________________________________________________________
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-- Remember: Adoption makes the corporation liable too, but does

not relieve P. So on this fact pattern, both the corporation and P are
liable.

VI. FOREIGN CORPORATIONS

Foreign corporations transacting business in this state must qualify and pay
prescribed fees.

A. A foreign corporation is one incorporated outside this state. Is Dunder-

Mifflin Paper Co., which is incorporated in Pennsylvania, foreign?
YES. ANYTHING OUTSIDE OF THIS STATE (DOESNT HAVE TO BE A FOREIGN
__________________________________________________________
COUNTRY.

__________________________________________________________

B. Transacting business means the regular course of intrastate (not interstate)

business activity. So it doesn’t include occasional or sporadic activity in this
state, and it doesn’t include simply owning property here.

C. The foreign corporation qualifies by getting a certificate of authority from

the Secretary of State. It gives information from its articles and proves good
standing in its home state. It must have a registered agent in this state and
pay fees too.

-- What happens if a foreign corporation transacts business without

qualifying? Two things: (1) civil fine and (2) cannot sue in this state (but it can
be sued and defend).

-- Once the corporation qualifies and pays back fees and fines, can it then
sue here?
GENERALLY YES.
__________________________________________________________

FACT PATTERN 2: ISSUANCE OF STOCK

I. WHAT IS AN ISSUANCE?
IT IS WHEN THE CORPORATION SELLS ITS OWN STOCK.
__________________________________________________________

__________________________________________________________

-- It is a way for the corporation to raise capital.

-- The rules in Fact Pattern 2 apply only when there is an issuance. That means
they apply only when the corporation is selling its own stock.
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-- Family Guy sells 3,000 shares of XYZ Corp. stock. Do the “issuance” rules here
in Fact Pattern 2 apply?

__________________________________________________________

__________________________________________________________

II. SUBSCRIPTIONS (written offers to buy stock from

the corporation)
A. Revocation of pre-incorporation subscriptions.

On January 10, S signs a subscription, offering to buy 100 shares of C

Corp., a corporation not yet formed. A week later, S changes his mind. Can
S revoke?

__________________________________________________________

__________________________________________________________

(Unless the subscription says otherwise or all subscribers agree to let you
revoke.)

B. Are post-incorporation subscriptions revocable?

__________________________________________________________

__________________________________________________________

C. What does that mean? At what point are the corporation and the subscriber
obligated under a subscription agreement?

__________________________________________________________

__________________________________________________________

III. CONSIDERATION—What must the corporation

receive when it issues stock?
A. Form of Consideration: split of authority here.

1. Every state agrees that these are permitted: (1) money (cash or
check), (2) tangible or intangible property, and (3) services already
performed for the corporation.

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2. The split of authority is over two other forms. In some states these
are OK and in some states they are prohibited (so using them
results in “unpaid stock,” meaning it’s all treated as water):

__________________________________________________________

__________________________________________________________

B. Amount of Consideration.

1. Par means “minimum issuance price.”

-- C Corp. is issuing 10,000 shares of $3 par stock. It must receive at

least

__________________________________________________________

-- Could it get more than $30,000?

__________________________________________________________

2. No par means “no minimum issuance price.” Board of directors sets

a price.

3. Treasury stock. This is stock the company issued and then reacquired.
It is considered authorized but unissued, and the corporation can then
resell it. If it does, the board sets any issuance price it wants.

4. Say the corporation issues stock in exchange for property or past

services. Who determines the value of the property or services?

__________________________________________________________

-- Is the board’s valuation conclusive?

__________________________________________________________

5. On the bar exam, if they give you par stock, watch for watered stock.

-- C Corp. issues 10,000 shares of $3 par to X for $22,000. The

corporation wants to recover the $8,000 of “water.” Who is liable?

a. Directors?

__________________________________________________________

__________________________________________________________

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b. X (the guy who bought the stock)?

(There is no defense; he is charged with notice of the par

value.)

c. What if X transfers the stock to third-party (TP). TP is not liable if:

__________________________________________________________

IV. PRE-EMPTIVE RIGHTS

A. A pre-emptive right is the right of an existing shareholder to maintain her
percentage of ownership by buying stock whenever there is a new
issuance of stock for money (cash or its equivalent, like a check).

-- Does “new issuance” include the issuance of treasury stock?

__________________________________________________________

-- S owns 1,000 shares of C Corp. There are 5,000 shares outstanding. C

Corp. is planning to issue an additional 3,000 shares. If S has pre-emptive
rights, then S has the right to

__________________________________________________________

__________________________________________________________

B. If the articles are silent, do we have pre-emptive rights?

__________________________________________________________

-- Suppose the C Corp. articles provide for pre-emptive rights. You own 20
percent of the stock of C Corp. C Corp. issues stock to Peggy Olson to
purchase property from Peggy. Do you have pre-emptive rights?

__________________________________________________________

__________________________________________________________

FACT PATTERN 3: DIRECTORS AND OFFICERS

I. STATUTORY REQUIREMENTS—DIRECTORS (adult
natural person)
A Number. ___________________________________________________

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B. Election. Initial directors are usually named in the articles. Thereafter, who
elects directors?

__________________________________________________________
-- The entire board is elected each year unless there is a
“staggered” board. A staggered board is divided into halves or
thirds, with one-half or one-third elected each year. A staggered
board is usually set in the articles.

C. Shareholders can remove directors before their terms expire – requires a

vote of a majority of the shares entitled to vote.

-- On what bases can shareholders remove a director?

__________________________________________________________

__________________________________________________________

D. Suppose there’s a vacancy on the board (e.g., a director resigns before her
term is up). Who selects the person who will serve as a director for the rest
of the term?

__________________________________________________________

__________________________________________________________

-- But if the shareholders created the vacancy by removing a

director, the shareholders generally must select the replacement.

E. The board of directors can only take an act in one of two ways.

1. Unanimous agreement in writing or

2. At a meeting (which has to satisfy the quorum and voting

requirements below).

-- What if directors agree to an act through individual conversations,

without a meeting or unanimous written agreement?

__________________________________________________________

-- Does a conference call (simultaneous oral communication so each

can hear all others) count as a meeting?

3. If there is a board meeting, method for giving notice is usually set in

the bylaws.

Regular meetings: is notice required? _______________________

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Special meetings: is notice required? ________________________

__________________________________________________________

-- Failure to give required notice voids whatever happened at the

meeting, unless the directors not notified waive the notice defect.
They can do this in writing anytime or by attending the meeting
without objecting.

-- Can directors give proxies or enter into voting agreements for how
they will vote as directors?

__________________________________________________________

__________________________________________________________

-- The rule is different for shareholder voting.

4. Quorum for meetings of the board — must have a majority of all

directors to do business (unless a different percentage is set in the
bylaws).

-- If a quorum is present at a meeting, passing a resolution (which is

how the board takes an act at a meeting) requires only a majority
vote of those present.

-- So, if there are 9 directors, at least _____ directors must attend

the meeting to constitute a quorum. If 5 directors attend, at least
_____ must vote for a resolution for it to pass.

-- Quorum of the board can be lost ("broken") if people leave. Once

a quorum is no longer present, the board cannot take an act at that
meeting.

-- The rule on this is also different for shareholder voting.

II. ROLE OF DIRECTORS

A. Generally, the board of directors manages the business of a corporation. So it
sets policy, supervises officers, declares distributions, determines when stock will
be issued, recommends fundamental corporate changes to shareholders, etc.

B. The board can delegate to a committee of one or more directors. But a

committee cannot do what?

__________________________________________________________

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-- Can a committee recommend such things to the full board for its action?

__________________________________________________________

III. DUTY OF CARE (Burden on the plaintiff)

Duty of care standard: A director owes the corporation a duty of care. She must act in
good faith and do what a prudent person would do with regard to her own business.

A. Nonfeasance (the director does nothing).

Justin Timberlake, a director of C Corp., fails to attend any of the board of

directors' meetings or to keep abreast of the company business in any way.
Will he be held liable for breach of the duty of care?

-- You must state the duty of care standard! Then apply standard: A prudent
person would attend some meetings and do some work. Justin never did
anything, so he has breached the duty of care. BUT HE IS LIABLE ONLY IF:

__________________________________________________________

__________________________________________________________

B. Misfeasance (the board does something that hurts the corporation – so

causation in these cases is clear).

The directors of Hedonists' Hot Tubs, Inc. vote to start a new line of hot
tubs with built-in wine coolers. The idea is a disaster and the corporation
loses money. Are the directors liable for breach of the duty of care?

-- State the duty of care standard! Then apply: Here, the directors' action
caused a loss to the corporation and was arguably imprudent given that it
turned out badly. BUT, a director is not liable if she meets the business
judgment rule (“BJR”).

BJR: A court will not second-guess a business decision if it (1) was

informed, (2) was made in good faith, (3) was made without conflicts of
interest, and (4) had a rational basis. The BJR means that a court will not
second-guess a board’s decision if it turns out badly, so long as the
decision was made on an informed basis, in good faith, with no conflicts
of interest, and with a rational basis.

So are the directors liable here for breach of the duty of care? It depends
on the facts. Was the board reasonably informed? Did it do appropriate
homework before making the decision (analyze information, deliberate)?
Did it act in good faith, free of self- interest, and with the belief that the
decision was in the best interest of the corporation? If so, the directors are
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not liable, despite the poor substantive outcome of the decision, because
the BJR recognizes that a director is not a ______________________
of success.

IV. DUTY OF LOYALTY (Burden on the defendant)

Duty of loyalty standard. A director owes the corporation a duty of loyalty. She
must act in good faith and with a reasonable belief that what she does is in the
corporation’s best interest.

Why does the BJR NOT apply in duty of loyalty cases?

__________________________________________________________

__________________________________________________________

A. Interested Director Transaction. This is any transaction between the

corporation (on the one hand) and one of its directors, or a close relative of
a director, or another business of the director (on the other hand).

-- Martha is a director of XYZ, Inc. If she sells wreaths to XYZ, Inc., it is an

interested director transaction.

-- State the duty of loyalty standard. The interested director transaction will
be set aside (or the director will be liable in damages) UNLESS the director
shows either: (1) the transaction was fair to the corporation when entered
into, OR (2) her interest and the relevant facts were disclosed or known and
the transaction was approved by either of these:

__________________________________________________________

__________________________________________________________

-- Special quorum rule: In many states, interested directors count toward a

quorum.

-- Even if the deal is approved by an appropriate group, say this:

__________________________________________________________

__________________________________________________________

-- Directors can set their own compensation as directors or officers, but it

must be reasonable and in good faith. If excessive, it is a waste of
corporate assets and a breach of the duty of loyalty.

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B. Competing Ventures.

Sharon is a director of Ozzie's Music Co. She can also serve on the board
of directors of Home Depot because it does not compete with Ozzie's. But
can Sharon start her own music company?
-- State the duty of loyalty standard. Then what do you say?

__________________________________________________________

__________________________________________________________

-- Remedy against Sharon if she goes into competition: constructive trust

on profits.

C. Corporate Opportunity (Expectancy).

Cheatem is a director of C Realty Corp., which develops condo projects.

Cheatem learns of some land that has been zoned for condos and buys it
for himself as an investment. What are C's rights, if any, against Cheatem?

-- State the duty of loyalty standard. Director cannot usurp a corporate

opportunity. That means the director cannot take it until he (1) tells the
board about it and (2) waits for the board to reject the opportunity.

-- What is a corporate opportunity? Some say it’s something in the

corporation’s line of business. There are other tests to throw in:

__________________________________________________________

__________________________________________________________

-- Is the company’s financial inability to pay for the opportunity a

defense?

__________________________________________________________

-- Remedy: If Cheatem still has it, he must sell it to the corporation at

his cost. If Cheatem has sold it at a profit, the corporation gets the
profit (constructive trust).

V. OTHER STATE LAW BASES OF DIRECTOR LIABILITY

A. Ultra vires acts. Responsible officers and directors are liable for ultra vires
losses.

B. Improper distributions.

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C. Improper loans. Curley, Moe, and Larry are the directors of XYZ Corp. The
board votes to lend Curley $100,000 of corporate funds. Is this OK?

__________________________________________________________

__________________________________________________________
-- Sarbanes-Oxley Act (federal law) generally forbids loans to executives in
large, publicly traded (“registered”) corporations. It requires the board of
such a large corporation to establish an audit committee and to oversee
work of registered public accounting firm. Chief executive and financial
officers must certify accuracy and completeness of financial reports.

D. Which directors are liable for all the things directors can be liable for?

1. A director is ___________________ to concur with board action

unless her dissent or abstention is noted in writing in corporate
records.

In writing means (1) in the minutes or (2) delivered in writing to

the presiding officer at the meeting or (3) written dissent
delivered to the corporation immediately after the meeting.
So an oral dissent alone is not effective.

-- Cannot dissent if you voted for the resolution at the meeting.

2. Exceptions.

a. An absent director is not liable for stuff done at the meeting

she missed.

b. A director is entitled to rely in ____________________ on

information (including financial information) presented by an
officer, employee, or committee (of which the relying director
was not a member), or professional reasonably believed
competent. This is a defense to liability.

VI. OFFICERS (owe the same duties of care and loyalty as

directors).
A. Status: Officers are agents of the corporation. So they can bind the
corporation by acts for which they have authority

__________________________________________________________

-- The president generally has implied actual authority (and apparent

authority) to bind the corporation to contracts in the ordinary course of
business.
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B. Traditionally, must have a president, secretary, and treasurer. Can have

others. Today, can one person hold multiple offices simultaneously?

__________________________________________________________

C. Selection and removal.

Officers are selected by and removed by the board, which also sets officer
compensation.

-- The board of Hair Care Extraordinaire, Inc. appoints John Stamos as

president. What happens if it fires him from the presidency?

__________________________________________________________

__________________________________________________________

-- IMPORTANT SUMMARY: So shareholders hire and fire directors, but the

board hires and fires officers. Generally, then, shareholders do NOT hire
and fire officers.

VII. INDEMNIFICATION OF DIRECTORS AND OFFICERS

A. Someone has been sued by (or on behalf of) the corporation in her
capacity as an officer or director. She has incurred costs, attorneys'
fees, maybe even fines, and there is a judgment or settlement in that
litigation. Now, she seeks indemnification (reimbursement) from the
corporation.

1. No indemnification allowed. When is the corporation barred from

indemnifying?

__________________________________________________________

__________________________________________________________

2. Mandatory – corporation must indemnify the person.

-- If she is successful in defending, on the merits or otherwise.

__________________________________________________________

__________________________________________________________

3. Permissive -- corporation may indemnify.

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a. Situations: anything not satisfying 1 and 2 above. Good

example:

__________________________________________________________

__________________________________________________________

b. Eligibility standards: Must show she acted in good faith and with
the reasonable belief that her actions were in the company's
best interests. This standard sounds familiar. Why?

__________________________________________________________

__________________________________________________________

c. Who determines eligibility? Disinterested directors or

disinterested shares or independent legal counsel.

B. Notwithstanding these rules, the court where the director or officer was
sued can order reimbursement if it is justified in view of all the
circumstances. If she was held liable to the corporation, this is limited to
costs and attorneys' fees (cannot include judgment).

C. Articles can eliminate director liability to the corporation for damages, but
not for intentional misconduct, usurping corporate opportunities, unlawful
distributions, or improper personal benefit.

-- Do these exculpatory provisions in the articles apply to officers too?

__________________________________________________________

FACT PATTERN 4: SHAREHOLDERS

I. DO SHAREHOLDERS GET TO MANAGE THE
CORPORATION?
A. The general answer must be NO. Why?

__________________________________________________________

B. BUT shareholders can run the corporation directly in a close corporation.

What are the characteristics of a close corporation?

__________________________________________________________

__________________________________________________________
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C. If the corporation’s stock is not traded on a national exchange,

shareholders can eliminate the board and run the corporation directly.

1. How can they do this? Either:

a. In the articles or bylaws and approved by all

shareholders or
b. By unanimous written shareholder agreement.

Either way, the agreement should be conspicuously noted on the

front and back of the stock certificates.

2. If the shareholders do this and eliminate the board, who owes the
duties of care and loyalty to the corporation?

__________________________________________________________

__________________________________________________________

3. In a close corporation, because it seems a bit like a partnership, it

may be that shareholders owe fiduciary duties not to oppress each
other. Especially, controlling shareholders should not oppress
minority shareholders, e.g., by selling control to people who loot the
corporation (without reasonable investigation of the buyer). If there’s
oppression, a harmed minority shareholder can sue the controlling
shareholder who oppressed her. Why do courts let shareholders sue
here?

__________________________________________________________

__________________________________________________________

D. Licensed professionals, including lawyers, medical professionals, and

CPAs, may incorporate as a “professional corporation” or “professional
association.” The name must have one of those phrases or “P.C.” or “P.A.”
The articles must state that the purpose is to practice in a particular
profession.

1. Directors, officers, and shareholders usually must be licensed

professionals. May the P.C. employ non-professionals?

__________________________________________________________

__________________________________________________________

-- Are the professionals personally liable for their malpractice?

__________________________________________________________
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2. Shareholders are generally not liable for corporate obligations or for

other professionals’ malpractice.

3. Generally, the rules governing regular corporations apply to the P.C.

II. CAN SHAREHOLDERS BE HELD LIABLE FOR THE

ACTS OR DEBTS OF THE CORPORATION?
A. The general answer must be NO. Why?

__________________________________________________________

__________________________________________________________

B. But a shareholder might be personally liable for what the corporation did if
the court “pierces the corporate veil” (PCV). In what kinds of corporations
can this happen?

__________________________________________________________

-- PCV standard: courts may PCV to avoid fraud or unfairness.

-- To PCV and hold shareholders personally liable,

1. The shareholders must have abused the privilege of

incorporating and
2. Fairness must require holding them liable.

(1) Classic fact pattern: Alter ego (identity of interests)

X and Y are the shareholders of C Corp. X commingles personal and

corporate funds, uses the corporate car as his own, and uses the corporate
credit card to pay for personal purchases. C Corp fails to pay its bills.

-- Can a creditor of the corporation who has been unable to collect its claim
from the corporation collect from either X or Y?

-- We start with the general rule (shareholders are not liable for corporate
obligations). Then PCV standard. Here a court MIGHT PCV if X's failure to
respect the separate corporate entity harmed creditors. Make the
argument (never sure how a court will rule, though).

(1) Did a shareholder abuse the corporation?

__________________________________________________________

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(2) Would it be unfair for X to have limited liability?

__________________________________________________________

-- If PCV, only X would be liable. Y has done nothing wrong.

(2) Classic fact pattern: Undercapitalization

S is a shareholder of Glowco, Inc., a corporation that hauls and disposes of

nuclear waste. Glowco does not carry insurance. Glowco has an initial
capitalization of $1,000. V is injured when one of Glowco's trucks melts
down. Can V sue S?

-- General rule (shareholders are not liable for corporate obligations); then
PCV standard. Here a court MIGHT PCV because the corporation was
undercapitalized when formed. Why?

__________________________________________________________

__________________________________________________________

-- Remember (always say this): Courts may be more willing to PCV for a tort victim
than for a contract claimant because, unlike a contract claimant, a tort victim did
not voluntarily choose to transact with the corporation and did not knowingly
assume the risk of limited liability.

-- We PCV to impose liability on shareholders for what should be a corporate debt.

Remember that another corporation can be a shareholder. Example: parent
corporation forms a subsidiary to avoid its own obligations.

__________________________________________________________

__________________________________________________________

III. SHAREHOLDER DERIVATIVE SUITS (SHAREHOLDER

AS PLAINTIFF)
A. In a derivative suit, a shareholder is suing to enforce the corporation's
claim, not her own personal claim. It’s a case in which the corporation is not
pursuing its own claim, so a shareholder steps in to prosecute it for the
corporation.

Always ask:

__________________________________________________________

__________________________________________________________
21
CORPORATIONS

If so, it is probably a derivative suit.

-- S, a shareholder of C Corp., sues the board of directors of C Corp. for

usurping corporate opportunities. Is that a derivative suit? YES—duty of
loyalty (and care) are owed to the corporation.
__________________________________________________________

__________________________________________________________

-- S sues the board of directors of C Corp. for issuing new stock without
honoring her preemptive rights. Is this a derivative suit?

__________________________________________________________

__________________________________________________________

-- S sues another shareholder for oppression in a close corporation. Derivative?

__________________________________________________________

__________________________________________________________

B. If the shareholder plaintiff wins the derivative suit:

Who gets the money from the judgment? __________________________

-- What does the shareholder plaintiff receive? Costs and attorneys’ fees,
usually from the judgment won for the corporation.

C. If the shareholder plaintiff (S) loses the derivative suit:

-- Can S still recover costs and attorneys' fees?

-- Is S liable to the defendant he sued for that defendant’s costs and

attorneys' fees?

Yes, if he sued without reasonable cause.

-- Can other shareholders later sue the same defendants on the same
transaction?

__________________________________________________________

__________________________________________________________

D. What are the requirements for bringing a shareholder derivative suit?

22
CORPORATIONS

1. Stock ownership when the claim arose and throughout the suit.

The person bringing suit must have owned stock at the time the
claim arose or have gotten it by operation of law from someone who
did own it then. What are examples of “operation of law?”

__________________________________________________________
2. Adequate representation of the corporation’s interest.

3. Must make a written demand on the corporation (usually that means the
board) that the corporation bring the suit. In many states you must always
make this demand, and cannot sue until 90 days after making the demand.

-- BUT in many other states, you don’t have to make this demand if it
would be futile. What is a good example?

__________________________________________________________

__________________________________________________________

4. The corporation must be joined – but as a defendant. Even though

the suit asserts the corporation's claim, the corporation did not do
so, so it is joined initially as a defendant.

5. Can the parties settle or dismiss a derivative suit?

__________________________________________________________

-- The court may give notice to shareholders and get their input on
whether to dismiss or settle.

E. Corporation can move to dismiss on the basis that independent

investigation showed the suit was not in the corporation’s best interest
(e.g., low chance of success or expense would exceed recovery).

-- This investigation must be made by independent directors or a court-

appointed panel of one or more independent persons.

-- In ruling on the motion, the court will look to see if those recommending
dismissal are independent and, if so, dismiss. But in some states, the court
will also make an independent assessment of whether dismissal is in the
company’s best interest.

IV. SHAREHOLDER VOTING

A. Who votes. General rule: the “record shareholder” as of the “record date”
has the right to vote.
23
CORPORATIONS

1. The record shareholder is the person shown as the owner in the

corporate records. The record date is a voter eligibility cut-off date.

-- C Corp. sets its annual meeting for July 7 and record date for June
6. S sells B her C Corp. stock on June 25. Who is entitled to vote the
shares at the meeting, S or B?
__________________________________________________________

__________________________________________________________

2. Exceptions to the general rule that record owner on record date votes.

a. The corporation re-acquires stock before the record date, so

it is the owner of this “treasury stock” as of the record date.
Does it vote this stock? _____________________________

b. Death of shareholder.

-- S owns stock in C Corp.; S is the record shareholder. After

the record date, S dies. Can S's executor vote the shares?
_____________________________________________

c. Proxies.

A proxy is a (i) writing (fax and e-mail are OK), (ii) signed by
record shareholder (e-mail OK if can identify sender), (iii)
directed to secretary of corporation, (iv) authorizing another
to vote the shares.

-- On February 2, 2012, S sends a letter to secretary of C

Corp. authorizing Don Draper to vote her shares. Can Don
vote S's shares at the 2012 annual meeting in July?

__________________________________________________________

-- Can Don vote S's shares at the 2013 annual meeting in July
2013?

__________________________________________________________

__________________________________________________________

-- What if, before the 2012 meeting, S writes to the secretary

of C Corp. that she now wants Jim Cramer to vote her shares
at the 2012 meeting?

__________________________________________________________

24
CORPORATIONS

-- Can S revoke her proxy even though it states that it is

irrevocable? _____________________________________

-- The only way to have an irrevocable proxy is if it is a “proxy

coupled with an interest.” This requires (1) the proxy says it’s
irrevocable and (2) the proxyholder has some interest in the
shares other than voting.
-- S sells B her shares after the record date but before the
annual meeting. S gives B an “irrevocable proxy” to vote the
shares at the annual meeting. Can S revoke this proxy?

__________________________________________________________

-- Here, the proxyholder has such an interest because she

OWNS the shares. But the interest does not have to be
ownership. For example, it could be an option to buy the shares
or a pledge of the shares—any interest beyond the simple
interest in voting the shares.

3. Voting trusts and voting agreements.

X, Y, and Z own relatively few shares of C Corp. They ask for your
advice on how they might increase their influence by "block voting,"
i.e., voting alike.

a. Requirements for voting trust. (10-year maximum.)

1) Written trust agreement, controlling how the shares

will be voted;
2) Copy to the corporation;
3) Transfer legal title to the shares to the voting trustee;
4) Original shareholders receive trust certificates and
retain all shareholder rights except for voting.

b. Requirements for voting ("pooling") agreement.

1) Can shareholders enter into voting agreements?

__________________________________________.

2) What is required?

__________________________________________________________

3) Are voting agreements specifically enforceable?

__________________________________________________________

__________________________________________________________

25
CORPORATIONS

B. Where do shareholders vote?

1. Shareholders usually take action at a meeting. Instead, they can act

by unanimous written consent signed by holders of all voting shares
(email is OK).

-- If they have a meeting, does it have to be in the state of

incorporation? _________________________________________

2. There are two kinds of shareholder meetings.

a. Annual meeting: to elect directors. If none held in 15 months,
a shareholder can petition the court to order one.

__________________________________________________________

b. Special meeting can be called by (1) the board or (2) the

president, or (3) the holders of at least 10 percent of the
voting shares, or (4) anyone else authorized in the bylaws.

-- 10 percent of the shares call a special shareholder meeting to

remove an officer. OK?

__________________________________________________________

__________________________________________________________

3. Notice requirement—must give written notice (fax or e-mail OK) to

every shareholder entitled to vote. Deliver it between 10-60 days
before the meeting.

a. Contents of the notice: always must state time and place of the
meeting. For special meetings, must also state the purpose of
the meeting. Why is the statement of purpose important:

__________________________________________________________

__________________________________________________________

b. Consequence of failure to give proper notice to all

shareholders—action taken at the meeting is void unless
those not sent notice waive the notice defect.

-- How can such waiver occur? In either of two ways:

1) Express–in writing and signed anytime (fax and e-mail

are OK)
2) Implied–attend the meeting without objection.

26
CORPORATIONS

C. How do shareholders vote?

There must be a quorum represented at the meeting. Determination of a

quorum focuses on the number of shares represented, not the number of
shareholders.

General rule: a quorum requires a majority of outstanding voting shares.

-- X Corp. has 120,000 voting shares outstanding. X Corp. has 700

shareholders. What or who constitutes a quorum?

__________________________________________________________

-- A shareholder quorum is not lost if people leave the meeting.

__________________________________________________________

-- If quorum requirement is met, an action will be deemed approved if the

votes cast in favor of the action exceed the votes cast against the action
(unless the articles provide for a greater voting requirement).

-- X Corp. has 120,000 voting shares outstanding. 62,000 voting shares are
represented at the meeting, but only 50,000 shares vote on a particular
proposal. How many shares must vote for the proposal for it to be accepted
by the shareholders?

__________________________________________________________

__________________________________________________________

D. How and when do shareholders use cumulative voting?

1. Cumulative voting is only available when shareholders elect

directors. It is a device to give small shareholders a better chance of
electing someone to the board.

2. For cumulative voting, multiply the number of shares times the

number of directors to be elected. You own 1,000 shares of stock in
C Corp. C Corp. has nine directorships open for election. You
believe that Napoleon Dynamite should be director of C Corp.
Under cumulative voting, how many votes can you cast for
Napoleon?

__________________________________________________________

__________________________________________________________

27
 CORPORATIONS

3. The articles of C Corp. are silent as to whether shareholders can

vote cumulatively. Do the shareholders have cumulative voting
rights?

__________________________________________________________

__________________________________________________________

V. STOCK TRANSFER RESTRICTIONS

One great thing about corporations is the transferability of the ownership interest.
A shareholder can sell or give her stock away. Sometimes people want to restrict
transferability, especially in a close corporation (to keep outsiders out). Can they?

-- Federline is a shareholder of Famous For No Reason, Inc. His stock is subject to

a stock transfer restriction that requires him to offer it first to the corporation (this
is a "right of first refusal"). Federline sells the stock to Joey Fatone in violation of
the agreement.

A. Stock transfer restrictions will be upheld provided they are reasonable

under the circumstances. What does that mean?

__________________________________________________________

__________________________________________________________

B. Is the deal enforceable against the transferee?

Even if the restriction is reasonable and thus valid, it cannot be invoked

against the transferee unless either (a) it is conspicuously noted on the stock
certificate or (b) the transferee had actual knowledge of the restriction.

VI. RIGHT OF SHAREHOLDER (PERSONALLY OR BY

AGENT) TO INSPECT (AND COPY) THE BOOKS AND
RECORDS OF THE CORPORATION
A. Standing: who can demand access?

__________________________________________________________

B. Procedure: shareholder must make a written demand stating the

documents desired and a proper purpose for inspection. What does proper
purpose mean?

__________________________________________________________
28
 CORPORATIONS

C. If the corporation fails to allow proper inspection, the shareholder can seek
a court order. If she wins, she can recover costs and attorney’s fees
incurred in making the motion.

D. By the way, do directors have to go through the procedure here to get

access to corporate books and records?

__________________________________________________________

__________________________________________________________

VII. DISTRIBUTIONS
These are payments by the corporation to shareholders. There are different types
of distributions: (1) dividends or (2) repurchase (a voluntary sale of a shareholder's
stock to the corporation) or (3) redemption (a forced sale of a shareholder’s stock
to the corporation at a price set in the articles).

A. Distributions are in the board's discretion. There is no right to a distribution until it

is declared. An action to compel declaration of a distribution is direct (not
derivative). To win, you must make a very strong showing of abuse of discretion.

-- For example, maybe if the corporation consistently makes profits and the
board refuses to declare a dividend while paying themselves a bonus.

B. Which shareholders get dividends? (Preferred, Participating, Cumulative,

Common)

-- We’ll do a series of four hypos on dividends. For each, the board of

directors declares dividends totaling $400,000. We need to determine
who gets what.

Who receives dividends if the outstanding stock is:

1. 100,000 shares of common stock. __________________________

2. 100,000 shares of common and 20,000 shares of preferred with a

$2 preference.

-- Preferred means pay first. 20,000 preferred shares multiplied by a

$2 preference equals a total preference of $40,000. That is paid first.
That leaves $360,000, which goes to the common shares. Because
there are 100,000 of those, each common share gets $3.60.

__________________________________________________________

__________________________________________________________
29
CORPORATIONS

3. 100,000 shares of common and 20,000 shares of $2 preferred

participating.

-- Participating means pay again. So these 20,000 shares get paid

first (because they are preferred) and also get paid again (because
they are participating). Work the preferred aspect just as in hypo #2:
20,000 shares multiplied by $2 equals $40,000 total preference.
Pay that first. That leaves $360,000, as in hypo #2.

__________________________________________________________

__________________________________________________________

4. 100,000 shares of common and 20,000 shares of $2 preferred that

is cumulative (and no dividends have been paid in the three prior
years). Cumulative means add them up.

-- A cumulative dividend accrues year-to-year. So the corporation

owes the cumulative holders for the three prior years, plus this
year (when the dividend was declared). That means the
corporation owes them four years' worth of a $2 preference. Four
years multiplied by $2 equals $8 per share. So the corporation
owes $8 to each cumulative preferred share. There are 20,000
such shares.

__________________________________________________________

__________________________________________________________

C. For any distribution (dividend, repurchase, redemption), which funds can

be used?

1. The traditional view requires us to talk about three funds.

a. Earned surplus. This is generated by business activity. It

consists of all earnings minus all losses minus distributions
previously paid.

-- May the board decide to use this fund for distributions? ___

b. Stated capital. This is generated by issuing stock (so is

capital surplus, which is below). So when the corporation
issues stock, it has to allocate the proceeds between stated
capital (here) and capital surplus (below).

-- Can stated capital be used for distributions? ____________

30
 CORPORATIONS

Hypo

C Corp issues 10,000 shares of $2 par stock for $50,000. Of that, how much is stated
capital and how much is capital surplus?

On a par issuance, the par value goes to stated capital. Here

that’s $20,000.

__________________________________________________________

-- And any excess over par goes to capital surplus. Here

that’s $30,000.

__________________________________________________________

On a no-par issuance, the board allocates the consideration

between stated capital and capital surplus.

c. Capital surplus. This is generated by issuing stock.

-- How is capital surplus computed? Payments in excess

of par plus amounts allocated in a no-par issuance.

-- Can capital surplus be used for distributions?

__________________________________________________________

__________________________________________________________

2. The modern view does not look at the funds. It says a corporation
cannot make a distribution if it is insolvent or if the distribution
would render it insolvent. Insolvent means either:

a. The corporation is unable to pay its debts as they come due;

or

b. Total assets are less than total liabilities (and liabilities include
preferential liquidation rights). We will see those rights
shortly.

D. Directors are jointly and severally liable for improper distributions.

Remember, however, the directors’ good faith reliance defense.

-- Shareholders are personally liable only if they knew the distribution was
improper when they received it.

31
 CORPORATIONS

FACT PATTERN 5: FUNDAMENTAL CORPORATE CHANGES

I. CHARACTERISTICS OF FUNDAMENTAL
CORPORATE CHANGES
A. These are extraordinary, so the board cannot do them alone. We need four
things:
1. Board action adopting a resolution of fundamental change.

2. Board submits proposal to shareholders with written notice.

3. Must get shareholder approval.

What shareholder vote is required?

4. In most of these changes, we need to deliver a document to the

Secretary of State.

B. Dissenting shareholder right of appraisal. What is this?

__________________________________________________________

__________________________________________________________

1. When will a shareholder have a dissenting shareholder right of

appraisal?

a. Actions by corporation to trigger right -- any of these:

1) Merger or consolidation;
2) Transfer of substantially all assets not in the ordinary
course of business; or
3) Transfer of shares in a share exchange.

-- BUT the right is not available if the stock is listed on a national exchange
or has 2,000 or more shareholders. This makes sense, because in such a
corporation there is a public market for the stock, so the unhappy
shareholder can sell on the market.

-- So this means the right of appraisal exists in

__________________________________________________________

b. What does the shareholder have to do to perfect her right of

appraisal?

32
 CORPORATIONS

1) Before shareholder vote, file with the corporation

written notice of objection and intent to demand
payment;

2) Abstain or vote against the proposed change; and

3) After the vote, within time set by corporation, make

written demand to be bought out and deposit stock
with the corporation.

2. If the shareholder and the corporation cannot agree on the fair value
of the shares, the court may appoint an appraiser.

3. Is the right of appraisal the shareholder’s only remedy for these

fundamental changes?

__________________________________________________________

II. AMENDMENT OF THE ARTICLES

A. Board of director action and notice to shareholders.

B. Shareholder approval.

Say there are 4,000 shares entitled to vote. For the meeting, only 3,000
shares attend. When voting on the proposed amendment, 2,000 shares
abstain, 501 shares vote yes, and 499 shares vote no. Does the proposed
amendment pass?

__________________________________________________________

C. If approved, deliver amended articles to the Secretary of State.

D. Are there dissenting shareholder rights of appraisal?

__________________________________________________________

III. MERGERS (B, Inc. merges into A Corp.) OR

CONSOLIDATIONS (A Corp. and B, Inc. form C Corp.)
A. Board of director action (both corporations), and notice to shareholders.

B. Shareholder approval (generally both corporations). As with others,

majority of shares entitled to vote.

33
 CORPORATIONS

C. No shareholder approval required if a 90 percent-or-more owned

subsidiary is merged into a parent corporation. What is this called?

__________________________________________________________

D. If approved, surviving corporation delivers articles of merger or

consolidation to the Secretary of State.

E. Remember the right of appraisal. Generally, for shareholders entitled to

vote on the merger or consolidation and also for shareholders of subsidiary
in short-form merger.

F. Effect of merger or consolidation: surviving corporation succeeds to all

rights and liabilities of the constituents. This makes sense because the
constituent corporation disappeared. So a creditor of that corporation can
sue the survivor. What is this called? ______________________________

IV. TRANSFER OF ALL OR SUBSTANTIALLY ALL OF

THE ASSETS NOT IN THE ORDINARY COURSE OF
BUSINESS, OR SHARE EXCHANGE (one company
acquires all the stock of another)

What constitutes “substantially all of the assets” varies from state-to-state. A rule
of thumb is that it requires transfer of at least 75 percent of the assets.

Most important point – these are fundamental corporate changes for which
corporation?

__________________________________________________________

-- S Corp. wants to sell all of its assets to B, Inc. or B, Inc. wants to buy all of the
stock of S Corp.

A. Board of director action (both corporations), and notice to selling

corporation’s shareholders.

B. Approval by transferring corporation's shareholders.

1. Number of shares of S Corp. that must approve the sale?

__________________________________________________________

34
 CORPORATIONS

2. Number of shares of B, Inc. that must approve?

__________________________________________________________

__________________________________________________________

C. Are there dissenting shareholders' rights of appraisal? Yes, for

shareholders of the selling corporation (but not for the shareholders of the
buying corporation).

D. Deliver to Secretary of State articles of exchange in share exchange.

Usually, there is no filing in a transfer of assets.

E. Do we expect successor liability in the sale of substantially all assets?

__________________________________________________________

__________________________________________________________

-- So the company that buys assets is not liable for the debts of the company
that sold the assets, unless the deal says otherwise or unless the company
buying the assets is merely a continuation of the selling corporation.

V. DISSOLUTION
A. Voluntary.

Board of directors action and approval by a majority of the shares entitled to

vote. File notice of intent to dissolve with the Secretary of State. Corporation
stays in existence to wind up. Notify creditors so they can make claims.

B. Involuntary (by court order).

1. A shareholder can petition for involuntary dissolution because of:

a. Director abuse, waste of assets, misconduct;

b. Director deadlock that harms the corporation; or
c. Shareholders have failed at two consecutive annual meetings
to fill a vacant board position.

-- As an alternative to ordering involuntary dissolution, court might

order buy-out of the objecting shareholder. When might this be
especially likely?

__________________________________________________________

__________________________________________________________
35
 CORPORATIONS

2. A creditor can petition because corporation is insolvent and (1) he

has an unsatisfied judgment or (2) the corporation admits the debt in
writing.
C. Dissolution is not the end of the corporation. It is the beginning of a
process that will end the corporate existence. The task now is to wind-up
(liquidate).

-- Winding up consists of: (a) gathering all assets, (b) converting to cash, (c)
paying creditors, and (d) distributing remainder to shareholders, pro-rata by
share unless there is a liquidation preference.

-- What's a liquidation preference? It means "pay first," so it works like a

dividend preference.

__________________________________________________________

__________________________________________________________

FACT PATTERN 6: FEDERAL SECURITIES LAW

I. SECURITIES ARE INVESTMENTS
A. Debt securities. The investor lends capital to the corporation, to be repaid
(usually with interest) as specified in the agreement. What is the debt
holder’s relationship to the corporation?

__________________________________________________________

1. Secured by corporate assets–“bond.”

2. Unsecured–“debenture.”

B. Equity securities. Investor buys stock from the corporation, which

generates capital for the business. What is the equity holder’s relationship
to the corporation?

__________________________________________________________

II. RULE 10b-5: AIMED AT DECEIT

This federal law prohibits fraud or misrepresentation (or nondisclosure) in
connection with the purchase or sale of any security (debt or equity). Elements:

A. At some point, the deal must use an “instrumentality of interstate

commerce” (mail, telephone, or trade on a national exchange).

36
CORPORATIONS

B. Transaction types

1. Misrepresentation of material information.

2. Insider trading: trading securities on the basis of material inside
information. But this is only a problem for someone high enough in
the business hierarchy that she has a duty to abstain or disclose.
Who has this duty?

__________________________________________________________

__________________________________________________________

__________________________________________________________

-- Such insiders cannot trade on secrets. They have a duty to abstain

or ensure disclosure so everybody's on the same footing.

3. Misappropriation. Under the misappropriation doctrine, a person

who owes a duty of trust and confidence to the source of the
information has a duty to abstain or disclose (e.g., a lawyer in a law
firm who discovers confidential information about a firm client who
is engaging in a merger; the lawyer owes a duty of trust and
confidence to his firm, which has been held, along with the client, to
be the source of the information).

4. Tipping. Here, an insider passes along material inside information

for a wrongful purpose.

C. Materiality. The misrepresentation or omission must concern a “material”

fact–one a reasonable investor would consider important in making an
investment decision.

D. Possible plaintiffs.

1. Securities and Exchange Commission (SEC).

2. Private action for damages by buyer or seller of securities

-- Widget Inc. issues a press release that Buffett has expressed an

interest in acquiring a major block of its stock. The release fails to
indicate that it is Jimmy Buffett and not Warren Buffett who is
interested. Because of this press release, Becky Katopolis does not
sell her Widget stock. Does Becky have a 10b-5 claim?

__________________________________________________________

37
CORPORATIONS

E. Possible defendants–“any person” (including entities).

1. Company that issues a misleading press release.

2. Buyer or seller of securities who misrepresents material information.

3. Buyer or seller of securities who trades on material inside information

(when there is a duty to disclose–again, comes from relationship of
trust and confidence with shareholders of the corporation).

4. Tipper or tippee.

a. L, an officer for X Co., learns that X Co. is planning to merge

with Y Corp. She telephones her son-in-law Joe about this,
and urges him to buy X Co. stock. Acting on the tip, Joe buys
the stock. Any violations of rule 10b-5?

L is a tipper because: (1) she passed along material inside

information in breach of a duty to X Co., and (2) she
benefited. How did she benefit?

__________________________________________________________

__________________________________________________________

-- Joe is a tipee because he (1) traded on the tip and (2) knew
or should have known that the information was improperly
passed.

b. D is a director of C Corp. While waiting for a concert to start,

D tells her husband about a new, secret processing method
that C Corp. has just developed. Bobbitt, who is sitting in the
next row, overhears the conversation and buys C Corp. stock
on a national exchange. Any violations of 10b-5?

-- NO. At worst, D was merely negligent, which is not enough

for 10b-5 liability. So there is no tipper. AND IN 10B-5, WHEN
THERE IS NO TIPPER, THERE CANNOT BE A TIPPEE.

F. Scienter. D must have an intent to deceive, manipulate, or defraud.

Recklessness may suffice.

G. Reliance. Said to be a separate element, as in fraud cases, but is presumed

in public misrepresentation (e.g., a misleading press release) and
nondisclosure cases.

H. Damages. Generally determined by an out-of-pocket measure.

38
 CORPORATIONS

III. SECTION 16(b): AIMED AT SPECULATION BY

DIRECTORS, OFFICERS, AND TEN PERCENT
SHAREHOLDERS. STRICT LIABILITY!
This federal law provides for recovery by the corporation of “profits” gained by
certain insiders from buying and selling the company’s stock. The theory is that it
is bad for market confidence to have these insiders buying and selling their own
company’s stock.
-- Because this creates a claim for the corporation, how might this come up?

__________________________________________________________

A. When does 16(b) apply?

1. “Reporting” corporation– (1) listed on a national exchange or (2) at

least 2,000 shareholders (or 500 non-accredited shareholders) and
$10,000,000 in assets. Accredited investor is a defined term
meaning, in general, an investor who can handle risk, such as an
institutional investor or a wealthy individual.

2. Types of defendants:

-- Director (either when she bought or sold) or

-- Officer (either when she bought or sold) or
-- Shareholder who owns more than 10 percent (both when she
bought and sold)

3. Type of transaction: Buying and selling stock within a single six-

month period (short-swing trading). No fraud or inside information is
needed.

B. What happens when 16(b) applies?

All “profits” from such “short-swing trading” are recoverable by the

corporation. If, within six months before or after any sale, there was a
purchase at a lower price, there is a profit.

__________________________________________________________

__________________________________________________________

-- D is a director of Acme, Inc., which is a reporting company. In 2007, D

bought 700 shares of Acme stock for $10 a share. In January 2012, D sold
700 shares for $6 a share. In March 2012, D bought 200 Acme shares for

39
CORPORATIONS

$1 a share. What result? Doesn't look like a profit in real-world terms. BUT D
owes the corporation $1,000.

Did she buy at less than $6 within 6 months before the sale in January
2012?

__________________________________________________________

Did she buy at less than $6 within 6 months after the sale in January 2012?

__________________________________________________________

__________________________________________________________

Multiply $5 profit times 200 shares. Why 200?

__________________________________________________________

__________________________________________________________

40