Texas Bar Exam Essays - Corporations
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What code governs Texas corporations?
Texas Business Organizations Code
What do you need to form a corporation in Texas?
(i) at least 1+ natural person/entity
(ii) certificate of formation
(iii) organizers/incorporators signs certificate (electronic/fax is ok) and send to SOS (which will file and return an acknowledgement of filing)
What is the purpose of a certificate of formation and what must it include?
- A certificate of formation is a K between (1) the corporation and shareholders and (2) the corporation and the state of Texas.
- Must include:
- --name of corp (including inc., co., or corp.)
- --name and addys of organizors
- --name and addys and phone of initial directors (or people who will manage corp)
- --name and addy of corporate agent for service of process
- --statement of purpose
- --capital structure: stock authorized, issued, and outstanding (issued and not yet reacquired)
What are ultra vires losses?
Ultra vires losses occur when a corporation participates in an activity that exceeds the scope stated in its certificate of formation. In this case, shareholders can seek injunction and responsible managers are liable to the corporation for ultra vires losses.
How long will a corporation exist if no period of duration is included in the certificate of formation?
If no period of duration is listed, then corporation presumed to exist for perpetual duration.
What happens after a certificate of formation is filed with the SOS?
A de jure corporation is formed (even if errors in COF). Then corporation holds an organizational meeting (after 3 days notice) to (1) select officers, (2) adopt bylaws, and (3) transact other company business.
What is the legal significance of formation?
- (1) Texas law governs affairs of corporation.
- (2) Corporation is a separate legal person who can sue and must pay taxes (unless it’s an S corporation with <100 U.S. shareholders and only one class of stock not publicly traded).
- (3) Liability rests with the corporation itself (shareholders have limited liability and only pay for their stock; not for business obligations).
What is a S corporation?
- (1) <100 shareholders
- (2) All U.S. citizens/residents
- (3) Only one class of stock
- (4) Not publicly traded
What happens if the proprietors fail to form a de jure corporation?
The shareholders will be liable for what the business does (i.e. it’s a partnership) unless (1) the de facto corporation doctrine applies or (2) the corporation by estoppel doctrine applies.
What is the de facto corporation doctrine?
- Relieves shareholders of personal liability (except in an action by the state) due to a failure to form a de jure corporation if:
- (1) unaware of failure to form de jure corp
- (2) parties made good faith effort to comply with TBOC
- (3) parties made some exercise of corporate privileges
- (4) Caveat: May be abolished in Texas
What is corporation by estoppel?
- Relieves shareholders of personal liability due to a failure to form a de jure corporation if:
- (1) unaware of failure to form de jure corp
- (2) one who treats a business as a corp may be estopped from denying the business’s corporation status
- (3) may also be used to prevent company from avoiding obligations by saying they lacked valid formation
- (4) applies in contract (not tort) cases
- (5) Caveat: May be abolished in Texas
Must a corporation have bylaws, and if so, what must corporate bylaws include and where must they be filed?
- --Must have bylaws unless a close corp.
- --TBOS doesn’t require any particular content for bylaws (but they generally lay out responsibilities, set regular meetings times, etc).
- --Bylaws don’t need to be filed with SOS; they are internal documents
How are bylaws created and revised?
Board adopts bylaws at the original meeting. Directors or shareholders can repeal or amend or adopt new bylaws.
What controls between the COF and bylaws?
COF except bylaws can still set number of directors.
Is a corporation liable for contracts entered into prior to the formation of the corporation?
Corp not liable until it adopts the contract by (1) express board action, or (2) implied (corp accepts benefits of contract)
What is a promoter?
Promoter is the person acting on behalf of a corporation that has not yet been formed. If this person enters into a contract on behalf of the non-existent corp, then they are liable unless (1) the contract says otherwise, or (2) novation agreement between promoter, corp, and 3rd party.
What is a foreign corporation?
Anything outside Texas; transacting business (intrastate transactions on a reoccurring basis, not sporadic); to qualify, must get a certificate of authority from SOS.
What is the consequence of a foreign corporation who failed to qualify and is found doing business in Texas?
- (1) civil fine
- (2) corp can’t sue in Texas on a claim arising from any business done in Texas
- (3) Corp can be sued
What is issuance of stock and what purpose does it serve?
Issuance occurs only when a corporation sells its own stock. This is a way for the corporation to raise capital.
What is subscription?
- Written, signed offers to buy stock from corporation.
- --Pre-incorporation subscriptions are irrevocable for 6 months
- --Post-incorporation subscriptions are revocable until acceptance by the corporation
- --When a Board accepts offer and corp notifies the subscriber in writing, corp and subscriber become obligated.
- --When subscriber pays for stock he comes a shareholder
When are shares considered “issued”?
Once full payment is received.
What type of consideration must be given for shares?
Shares may be issued in exchange for any benefit (tangible or intangible, past or present) to the corp.
What amount of consideration must be given for shares?
- Par – Minimum issuance price set in COF; can always go over par but not under
- No Par – No minimum issuance price (board can set any price)
What is treasury stock?
Stock that was previously issued and has been reacquired by corp; its status is authorized and issued, but not outstanding; always treated as no par.
What is watered stock?
Par stock issued for less than par value
Who is liable for watered stock?
- (1) Directors if the knowingly issued it
- (2) Guy who bought it
- (3) If 3rd party involved (i.e. purchaser transferred it), not liable if had no knowledge of the watered stock
What are pre-emptive rights?
Rights of an existing shareholder to maintain her percentage of ownership by buying stock whenever there is (1) a new issuance of stock for money (cash or cash equivalent, BUT NOT for property) after 6 months of formation or (2) a sale of treasury stock after 6 months of formation
What gives a shareholder pre-emptive rights?
- If COF/AOI silent, still automatic if before 9/1/03
Who can be a director?
1+ adult, natural person; elected by shareholders at annual meeting
How is the number of directors initially set?
Number of directors initially set in the COF, but can be changed in COF or bylaws
How can a director be removed before his term expires?
By shareholders - by vote of majority of shares entitled to vote, with or without cause; vacancy generally selected by board or shareholders
How can a board act?
- (1) unanimous written consent (email/fax ok) to do something; or
- (2) meeting that satisfies quorum and voting requirements [no proxies/voting agreements allowed] (can conference call = ok)
What is the effect of a non-compliant act by the board?
It is void.
When is notice of a board meeting required?
- Regular board meetings – no notice required
- Special board meetings – notice must be given that states time and place; notice by e-mail is ok IF director authorizes it
What is the effect of failing to give notice of a board meeting?
Voids anything done at the board meeting unless the defect waived by person not notified either in writing or by attending without objection.
What is a quorum?
A quorum is the number of directors required to business at a meeting; generally must have a majority of all directors present (at all times???), and then to pass an act a majority of those present must vote in the affirmative.
What is the role of a director?
- (1) manage business of corporation
- (2) set policy
- (3) supervise officers
- (4) declare distributions
- (5) decide when to issue stock
- (6) recommend fundamental corporate changes to the shareholders
- (7) Exceptions: close corporations; shareholder agreements
What duty does a director owe?
Duty of Care – Director owes fiduciary duty of care and loyalty; must exercise ordinary care and prudence and act in good faith. Can breach either by (1) nonfeasance (doing nothing), but liable only if that causes a loss to corp or (2) misfeasance (doing something that hurts corp), not liable though if the Business Judgment Rule applies)
Duty of Loyalty – must act in good faith and with a reasonable belief that what she does is in the corp’s best interest. Business Judgment Rule does NOT apply (b/c can’t apply in cases where there is a conflict of interest!
Ultra vires act
Who has the burden of proving a director’s breach of his duties?
- Plaintiff has burden of proof on Breach of Duty of Care claim
- Defendant has burden of proof on Duty of Loyalty claim
What is the Business Judgment Rule?
If a director makes a decision that harms the corp, they are not liable if they acted prudently (i.e. they did their homework, analyzed the decision, and deliberated before making the decision). BJR does NOT apply in Duty of Loyalty claims (b/c it can’t apply in duty of loyalty cases)!
When has a director breached his duty of loyalty and what happens to those deals?
- (1) Interested Director Transactions – set aside unless D shows (i) deal was fair to corp when approved or (ii) her interest and the material facts were disclosed or known and the deal was approved in good faith by either (A) a majority of disinterested directors or (B) shareholders. Note: The interested director counts toward quorum; BOD can set its own compensation as long as reasonable w/o violating the duty of loyalty.
- (2) Competing Ventures – must have approval from disinterested directors; remedy is constructive trust on profits, if any sold.
- (3) Corporate Opportunity – director cannot usurp a corporate opportunity until he (1) tells the board and (2) waits for the board to reject the opportunity. Note: This restriction can be waived in the COF.
Which director is liable for a breach of one of their duties?
All of them are liable – a director is presumed to have concurred with Board action UNLESS his dissent or abstention is noted in writing in corp records (i.e. (1) in minutes, (2) sending note to corp secretary at meeting, or (3) sending registered letter to corp secretary immediately after the meeting. Exceptions: D absent, good faith reliance of financial statements provided by an officer, a competent professional, an employee, or by a committee of which the D relying was not a member.
Who selects Officers and what positions are selected?
BOD hires and fires officers. Must have at least a President and a Secretary (one person can hold both, and they can be directors).
Who hires and fires directors?
What is the relationship between officers and the corporation?
Officer = agenct of corporation; Corporation = principal
What duty do Officers of the corp owe?
Duty of Care and Duty of Loyalty (same as owed by Directors)
When is a Director or Officer eligible for indemnification?
Reimbursement Prohibited – if D or O HELD liable for willful/intentional misconduct in performing duty (even if COF tries to eliminate liability for D or O).
Reimbursement Required – if D or O wins a judgment on the ENTIRE CASE then the corp must pick up her tab.
Reimbursement Permitted – anything not prohibited/required is permitted; D or O must show she acted in good faith and with a reasonable belief her actions were in best interest of corp.
Who determines whether a Director or Officer is eligible for indemnification?
- (1) majority vote of disinterested D’s or of disinterested committee or of disinterested shares
- (2) independent legal counsel
- (3) regardless of foregoing, court in which D or O sued can order corp to reimburse if finds it would be justified
What is a close corporation?
- (1) <100 shareholders
- (2) Not publicly traded
- (3) COF must say “Close Corporation”
- (4) Don’t need BOD
- (5) Shareholders manage corp
- (6) To change management structure, need a written shareholder agreement by ALL shareholders authorizing the change.
- (7) Once operating under Shareholder Agreement, corp may file a “Statement of Operation” with the SOS > makes it a matter of public record = notice to all shareholders and transferees
What duties do shareholders owe in a close corp?
Duty of Care and Duty of Loyalty
Do not owe fiduciary duties amongst and to shareholders as a matter of law, BUT court can find that fiduciary duties are owed.
Are shareholders in a close corp liable for acts or debts of corp
Generally, shareholders not liable unless court pierces the corporate veil (PCV)
What is Piercing the Corporate Veil (PCV)?
Shareholders held liable for acts or debts of corp if they have abused the privilege of incorporating and limited liability would be unfair (by promoting fraud or preventing equity).
What are two instances when Piercing the Corporate Veil is common?
Alter-ego: shareholder failed to separate corp entity from personal and this harmed creditors
Undercapitalization: shareholder failed to invest enough to cover prospective liabilities
What is a derivative suit and who recovers?
Shareholder is suing to enforce the corporation’s claim (not his own personal claim).
If shareholder wins, corp gets the money since it’s the corp’s claim, but shareholder reimbursed for attorneys fees and costs. BUT if close corp with <35 members, the court MIGHT deem the suit a direct action in which case shareholder would get the money.
If shareholder loses, can’t recover costs and may be liable to the defendant he sued if the court finds that shareholder sued without reasonable cause or for an improper cause.
What requirements must a shareholder satisfy in order to bring a derivative suit?
- (1) Stock ownership when claim arose (or got it by operation of law from someone who did)
- (2) Fairly and adequately represent corp’s interest
- (3) Must make a written demand on directors that corporation bring the suit and give info on the suit with particularity
- (4) Corp must be joined as a defendant in the case
How can a derivative suit be terminated?
- (1) settled or dismissed ONLY with court approval
- (2) Tried by fact finder
Who can vote?
Record shareholder as of record date.
- Record shareholder – person shown as the owner in the corp records
- Record date – cut-off date to vote set no more than 60 days before the meeting
Exceptions: (1) does not vote treasury stock; (2) Shareholder dies (executor votes); (3) proxy (i) writing, fax, or email, (ii) signed by record shareholder, (iii) directed to Secretary of corp (iv) authorizing another to vote shares
What is a proxy agreement and what are its requirements?
Proxy = (i) writing, fax, or email, (ii) signed by record shareholder, (iii) directed to Secretary of corp (iv) authorizing another to vote shares.
Proxy agreements are revocable (even if it says irrevocable) UNLESS the proxy is coupled with an interest (i.e. the proxy holder has some interest other than voting (i.e. purchased the stocks within the 60 day window and then is assigned as proxy).
Proxy agreements good for 11 months unless is states otherwise.
How can shareholders pool their voting power?
Use Voting Trusts/Agreements
- (1) Must be for a valid purpose
- (2) No time limit imposed by corp law
- (3) NOT available for Directors
- (4) If a person is both a shareholder and a director, look at the hat they are wearing at the time of the voting
What is the difference between a Voting Trust and a Voting Pooling Agreement?
Voting Trust – written agreement controlling how shares will be voted; file copy with corp; transfer legal title of shares to voting trustee; original shareholders receive trust certificates and retain all other shareholder rights outside voting.
Voting Pooling Agreement – writing detailing agreement with copy sent to corp
Where do shareholders vote? >Corp act
Only when (1) unanimous consent in writing and signed by holders of all voting shares or (2 )meeting that satisfies voting/quorum rules.
- Two kinds of shareholder meetings:
- (1) Annual meeting MUST be held (i.e. to elect Directors) > if none is held w/in 13 months, shareholder may petition the court to order one.
- (2) Special meeting: can be called by (1) the board, (2) the president, (3) holders of at least 10% of the shares entitled to vote, or (4) anyone else permitted on COF.
- Note: Shareholders DO NOT remove Officers, Only Directors!
Are shareholders entitled to notice?
Yes – shareholders are entitled to notice for every meeting 10-60 days pre-meeting (21-60 if fundamental change considered); must be given personally ro by mail (if shareholder consent can give by e-mail); contents of notice must state: when, where, and purpose of the meeting
What is the consequence of failing to give shareholders proper notice of a meeting?
Failure to give proper notice to all shareholders entitled to vote > action taken at the meeting is void UNLESS waiver occurs by (1) express (in writing) or (2) implied (attend meeting without objecting).
How do shareholders vote?
Quorum requires a majority of the outstanding shares to be represented
Quorum can be changed by COF, but never less than 1/3 majority
Once quorum established, it’s not lost if people leave the meeting (as is the case with Directors)
What is cumulative voting and how does it apply to shareholders?
Multiply # of shares by # of directors
If COF is silent as to whether shareholders can vote cumulatively, they CANNOT!
What are stock transfer restrictions?
Limits how much stock someone can own. These are ok if not an undue burden on alienation. Right of first refusal is ok also.
For close corps, set up restriction in COF, bylaws, or agreement.
How can stock transfer restrictions be invoked against a transferee?
Even if restriction is reasonable and valid, it cannot be invoked against the transferee UNLESS either (i) it is conspicuously noted on the stock certificate or (ii) the transferee had actual knowledge of the restriction.
Do shareholders have a right to inspect and copy books and records of corp?
Any shareholder who has (1) owned stock (or held a voting trust certificate) for at least 6 months or (2) owns at least 5% of the outstanding shares can make a written demand stating a proper purpose (one related to interest as a shareholder). If litigation ensues, corp has burden of proving that shareholder purpose was improper.
Any other shareholder must get a court order before they can inspect the books
Directors have unfettered access to the books.
What are distributions?
Payments by the corp to shareholders. Can be (1) a dividend, (2) to repurchase shares, or (3) to redeem shares (forced sale)
Distributions are declared in board’s discretion; no right unless board declares it.
How can a shareholder force distributions?
Institute an action to force a distribution, but must make a strong showing of abuse of discretion (profits for last 3 years w/ no distribution yet the board pays itself a bonus)
What are the different types of stock?
Common Stock – split whatever the distribution is, unless preferred or participating exists
Preferred Stock – these shareholders get paid first
Preferred Participating Stock – get paid first and get paid on split to common shares
Preferred Cumulative Stock – paid first and if dividend is skipped on year, add year
What funds are eligible for distribution?
Surplus (assets-liabilities-stated capital = surplus)
Stated capital is NEVER eligible > capital = stated par, the excess = surplus
Corp can make distribution if it lost money during a year, but corp CANNOT make any distribution if its insolvent or distribution would render it insolvent.
What are the consequences of a director for making an unlawful distribution?
Directors are jointly and severally liable; can seek contribution from other directors; can assert a defense of good faith reliance if applicable
How can the COF be amended?
- (1) Board action
- (2) Shareholder approval of at least 2/3 shares entitled to vote – no rights to appraisal
- (3) If approved, deliver to SOS for filing
How can a corporation merge?
- (1) Board action by both corps
- (2) Shareholder approval (2/3 entitled to vote UNLESS a 90% or more owed subsidiary merged into parent = Short Form Merger)
- Note: The right of appraisal available to shareholders of both companies in regular merger and shareholders of subsidiary in short-form (parent co merger) > effect – the surviving company succeeds to all the rights and liabilities of the disappearing company (“successor liability”)
What is conversion?
Corp can convert to another form of business organization.
- Requirements include:
- (1) board action
- (2) 2/3 entitled shareholder vote
- (3) Delivery of certificate of conversion to SOS
- (4) Dissenting shareholder have right of appraisal
What actions can the board of directors not take alone?
Acts that would be considered extraordinary occurrences.
- Extraordinary occurrences requires that:
- (1) Board takes action adopting resolution of fund change
- (2) Board submits proposal to shareholders with written notice of at least 21 days
- (3) Fund change must be approved by shareholders (vote req’d = 2/3 of shares entitled to vote (super majority)
- (4) Document filed with SOS
What is a Right of Appraisal?
Brought by a dissenting shareholder, forcing corp to buy his stock at a fair value (mainly occurs with close corps).
Right is triggered by (1) merger, sale of shares in share exchange, (2) transfer of substantially all assets, or (3) conversion.
To perfect, must: (1) before vote, file with the corp written notice of objection and intent to demand payment, (2) abstain or vote against proposed changes, and (3) after vote w/in 20 days of notification by corp, make a written demand to be bought out.
What is the effect of the transfer/sale of all or substantially all o the assets not in the ordinary course of business?
Must be ALL (i.e. corp can’t continue to engage in the same business after the transfer).
This is a fundamental corp change for the SELLER ONLY (not the buying corp)
Do not expect successor liability because the selling corp still exists afterwards
Requires: (1) board action (both corps) and (2) approval by transferring/selling corp’s shareholders (rights of appraisal for shareholders of transferring/selling company only)
How can a corporation be terminated?
Involuntary or voluntary termination.
- Voluntary termination requires:
- (1) written consent of all shareholder, or
- (2) board of directors action and approval by 2/3 shares entitled to vote
- (3) after either 1 or 2 met, send notice of intent to wind up to creditors
- (4) then follow liquidation process
- (5) a court can revoke termination if the corp was terminated as a result of fraud
- (6) a corp may revoke its termation at any time before its corp existence ceases
- Involuntary termination:
- (1) court order
- a. By Texas Attorney General
- b. Creditors – seeks receiver b/c corp insolvent
- c. Shareholder – seeks receiver b/c insolvent, or illegal, oppressive, or fraudulent acts by directors; receiver appointed for 12 months after which time court can terminate if issues not resolved
- d. Administrative termination – issued by SOS, corp must be given 90 days notice; directors and officers remain personally liable for debts incurred after termination until reinstatement occurs (but if corp not reinstated, it is treated as a voluntary termination and proceeds to liquidation)
How can a termination be revoked?
A court can revoke termination if the corp was terminated as a result of fraud.
A corp may revoke its termation at any time before its corp existence ceases.
What is the liquidation process?
- Board manages process (unless court decides to supervise) which includes:
- (1) Gather all assets
- (2) Convert to cash
- (3) Pay creditors
- (4) Distribute remainder to shareholders, pro-rata by share UNLESS there is a liquidation preference (pay first)
How long can claims be asserted against a terminated corporation?
Claims that arose against the corp BEFORE the termination can be asserted within 3 years of termination of the corp.
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