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Corporate bargain--limited liability
I.CHARACTERISTICS OF A CORPORATION
A.PRINCIPAL CHARACTERISTICS OF A CORPORATION
a)Entity Status--a corporation is a legal entity created under the authority of legislature
b)Limited Liability--as a legal entity, a corp is responsible for its own debts; its sh’s liability is limited to their investment;
c)Free Transferability of Interest--shares, representing ownership interests, are freely transferable;
d)Centralized Management and Control--a corp’s management is centralized in a board of dirs and officers. Shs have no direct control over the board’s activities;
e)Duration--Continuity of Existence--a corp is capable of perpetual existence;
f)Taxation--a corp, as an entity, pays taxes on its own income; shs are taxed only on dividends;
g)Remember Attributes of the Corporation--CLIFF:
1)Centralization of management;
2)Limited liability;
3)Forever (perpetual duration);
4)Freely alienable (shares can be sold).
B.CORPORATIONS DISTINGUISHED FROM OTHER FORMS OF BUSINESS ASSOCIATIONS.
1.GENERAL PARTNERSHIPS--in most states, p’ships are governed by the Uniform Partnership Act (UPA). However, the Revised UPA (RUPA) has been adopted by a few states
a)Aggregate Status--a p’ship is an aggregation of two or more persons who are engaged in business as co-owners. Although not a legal entity, a p’ship is treated as one for certain purposes, e.g., ownership and transfer of property. RUPA confers entity status on p’ships;
b)Unlimited Liability--every partner is subject to unlimited personal liability on p’ship debts;
c)Transferability of Interests--a partner cannot make a transferee a member of the p’ship. She can, however, assign his interest in the p’ship, thus permitting the assignee to receive distributions of profits. Because the assignee does not become a member of the p’ship, he is not entitled to participate in p’ship business or management.
d)Duration and Dissolution--a p’ship cannot have perpetual existence. It is terminable at will unless a definite term is expressed or implied, and is also dissolved by death, incapacity, or withdrawal of any partner.
1)Wrongful dissolution--p’ships can also be dissolved in contravention of the p’ship agreement, by the express will of any partner, by a court or by a partner’s conduct. Upon wrongful dissolution, nonbreaching partners may seek damages for breach and, if they choose to do so, may continue the p’ship upon payment to the breaching partner of the value of his interest.
1)Compare--dissociation under RUPA--termination results in either the winding up of the p’ship or buyout of the dissociating partner, depending on the event triggering the termination. A buyout may be reduced by damages if dissociation was wrongful.
e)Management and Control--absent a contrary agreement, every partner has a right to participate equally in the partnership management.
f)Autority--each partner, as an agent of the firm, may bind the p’ship by acts done for the carrying on, in the usual way, the business of the p’ship.
1)RUPA--a p’ship is bound by a partner’s act for carrying on in the usual way either the actual p’ship business or a business of the kind carried on by the p’ship.
g)Ownership of Property--title may be held in the name of the p’ship, but property is owned by the individual partners as tenants in p’ship. There is no tenancy in p’ship under RUPA, which provides that property acquired by p’ship is owned by p’ship, not individual partners.
h)Capacity to Sue and be Sued--under the UPA, a lawsuit may be brought by or against individual partners, rather than p’ship. Partners are jointly and severally liable for wrongful acts and breaches of trust; they are only jointly liable for debts and obligations of the p’ship.
1)Statutory reforms--many state statutes specifically allow a p’ship to be sued in its own name. Other states make all p’ship liabilities joint and several. Other reforms provide that not all joint obligors need to be joined in a suit.
2)RUPA--a p’ship may sue and be sued in its own name, and partners are jointly and severally liable for all p’ship obligations. A claim against the p’ship cannot be satisfied from a partner’s personal assets unless p’ship assets have been exhausted.
2.JOINT VENTURE--a p’ship formed for some limited investment or operation, as opposed to a continued business enterprise. Joint ventures are governed by the rules applicable to p’ships
3.LIMITED PARTNERSHIP--this is a p’ship consisting of two classes of partners: generalpartners (with rights and obligations as in an ordinary p’ship) and limited partners (with no control and limited liability).
4.LIMITED LIABILITY PARTNERSHIPS--in a LLP, a general partner is NOT personally liable for all p’ship obligations arising from negligence, wrongful acts, and misconduct absent his involvement in the misconduct. There is no exclusion for liability for contractual obligations.
5.LIMITED LIABILITY COMPANIES--LLC is a non-corporate business entity whose owners (members) have limited liability and can participate actively in its management. An LLC may be either for a term or at will. It can be managed either by its members or nonmember managers. Depending on the statute, distributions are made either equally to each member or in proportion to each member’s contribution.
a)Withdrawal and Dissolution--some statutes provide that any event that terminates a member’s membership (death, resignation) causes dissolution. Other statutes distinguish between fault events(member misconduct...) and non-fault events (death, bankruptcy), and some provide that dissolution can be avoided by paying the withdrawing member fair value for his interest.
b)Advantages of LLCs--An LLC for a business association, not publicly held, has strong advantages: partnership taxation, virtually no restrictions in structuring ownership interests and management, limited liability for owners and managers, and no limitations on the number or nature of owners.
C.DISREGARD OF CORPORATE ENTITY--since a corp is a distinct legal entity, shs are normally shielded from corporate obligations. In certain instances, however, the corporate entity will be disregarded.
1.PIERCING THE CORPORATE VEIL--(Suits by corporate creditors againstshs)--it’s more common in contract claims than in tort claims. The most important elements considered by the courts:
a)Commingling of Assets--commingling of corp assets and personal assets of shs (e.g., paying private debts with corp funds) may lead to piercing of the corporate veil;
b)Lack of Corporate Formalities--whether basic corp formalities (e.g., regular meetings, corporate records maintained, issuance of stock) were followed is also relevant. Statutory close corps are permitted more flexibility regarding corp formalities;
c)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 corp’s initial registered office, name of initial registered agent, and the name and address of each incorporator.
a)Purpose Clause--under most statutes, no elaborate purpose clause is needed. It is sufficient to state that the purpose of the corp is to engage in any lawful business activity.
b)State of Incorporation--incorporators need to consider how flexible the state’s corporate law is versus the costs associating with incorporating in that state
2.ORGANIZATIONAL MEETING--filling the articles in proper form creates the corporation, after which an 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 mandatoryrequirements.
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 doesn’t necessarily abolish estoppel.
d)De Facto is For All; Estoppel is For One--estoppel depends on relationship between party and corp.
4.WHO MAY BE HELD LIABLE--when a would-be corp is not a de jure or de facto or a corp by estoppel, the modern trend imposes personal liability against only those owners who actively participated in management of the enterprise.
5.EFFECT OF STATUTES:
a)On De Facto Doctrine--states following the prior version of the Model Act have abolished the de facto doctrine, thus making all purported “shs” jointly and severally liable for all liabilities incurred as a result of the purported “incorporation.” However, statutes based on Revised Model Business Corporation Act require a person acting on behalf of the enterprise to know that there was no incorporation before liability attaches.
b)On Estoppel Doctrine--the effect of both acts is an unsettled issue.
c)On Liability--under the prior Model Act, liability extends to investors who also exercise control or actively participate in policy and operational decisions. It is expected that the Revised Model Act will be interpreted in the same manner.
III.LIABILITIES FOR TRANSACTIONS BEFORE INCORPORATION.
A.PROMOTERS--a promoter participates in the formation of the corp, usually arranging compliance with the legal requirements of formation, securing initial capital, and entering into necessary contracts on behalf of the corp during the time it’s being formed.
a)Fiduciary Duties to Each Other--Full disclosure and fair dealing are required between the promoters and the corp and among promoters themselves.
B.CONTRACTS MADE BY PROMOTERS ON CORP’S BEHALF
1.RIGHTS AND LIABILITIES OF CORPORATION:
a)English Rule--the corp is not directly liable on pre-incorporation contracts even if later ratified. Rationale: the corp was not yet in existence at the time the promoter was acting.
b)American Rule--the corp is liable if it later ratifies or adopts pre-incorporation K.
c)Corporation’s Right to Enforce Contract--under either rule, the corp may enforce the contract against the party with whom the promoter contracted, if it chooses to do so.
2.RIGHTS AND LIABILITIES OF PROMOTERS.
a)Liability on Pre-incorporation Contract--generally, promoters are liable if the corp rejects the pre-incorporation contract, fails to incorporate, or adopts a contract but fails to perform, unless the contracting party clearly intended to contract with the corporation only and not with the promoters individually.
b)Right to Enforce Against the Other Party--if a corp is not formed, the promoter may still enforce the contract.