Spring 2005 Corporations Outline
1.1 Different conflicts in corporate law
1.1.1 Conflicts between shareholders and managers.
1.1.2 Conflicts between shareholders and debt-holders.
1.1.3 Conflicts between controlling Shareholders and non-controlling Shareholders
1.2 Corporations are governed by statute and by common law.
1.2.1 Delaware law is the king
1.2.2 Oklahoma has generally adopted Delaware law.
1.2.3 Because Oklahoma adopted Delaware law, Oklahoma courts look to Delaware
case law to interpret like provisions
1.2.4 Corporations can operate in any state they choose even if they are incorporated
1.3 The Players
1.3.1 Shareholders own the corporation: they own the shares and are residual claimants
on the corporation’s assets (everyone else comes first).
184.108.40.206 Shareholders can vote on major decisions including merger, amending the
articles of incorporation, a sale of substantially all of the corporate assets,
dissolution, removal of directors, and election of directors.
1.3.2 Directors operate the corporation. DGCL § 141.
220.127.116.11 Directors need not be full-time employees of the corporation.
18.104.22.168.1 Directors work for other corporations and periodically
evaluate the position of the corporation for which they
serve as a director.
22.214.171.124.2 Directors appoint officers who run the day-to-day
operations of the corporation.
126.96.36.199.3 Directors may be officers as well.
1.3.3 Officers run the day-to-day operations of the corporation. DGCL § 142.
1.4 Agency costs of a corporation – what can we do to make sure that the directors and
officers act in the best interests of shareholders?
1.4.1 Monitoring – Shareholders can keep track of what directors and officers are
doing. but this imposes costs on the corporations.
188.8.131.52 Independent auditors are one form of monitoring
1.4.2 Bonding – We can bond the directors’ & officers’ interests to the assets, making
their compensation dependent on the corporation’s performance.
1.4.3 Residual losses – Some losses cannot be avoided by monitoring and bonding
because bonding and monitoring cannot cover every aspect of the business
1.4.4 Abuses by the directors & officers can injure shareholders
2 Different Business Entities. See Characteristics of Various Business Organizations.
2.1 Characteristics of a corporation
2.1.1 Limited Liability – Shareholders are generally liable only for their DGCL §
2.1.2 Centralized management – Shareholders do not mange the corporation, but elect
directors, DGCL § 141, who choose officers, DGCL § 142, who in turn run the
day-to-day operations of the corporation.
2.1.3 Transferability – Shares in a corporation generally are freely alienable.
184.108.40.206 Some restrictions are possible in the articles. DGCL § 202.
220.127.116.11 Some shares are practically restricted because there is no market (i.e.Small corporations for which valuation is difficult).
18.104.22.168 Limited liability facilitates transferability – without it, shares would be
difficult to sell.
2.1.4 A corporations has perpetual life.
2.1.5 Corporations are subject to two levels of taxation.
22.214.171.124 There is a corporate entity level tax of 30%.
126.96.36.199 Shareholders are taxed on any dividends
2.2 Every corporation formed in Delaware must maintain a registered office in Delaware.
DGCL § 131(a).
2.2.1 A corporation may be incorporated in Delaware and operate or be headquartered
2.2.2 Corporations choose where to incorporate based on different criteria:
188.8.131.52 State corporation law;
184.108.40.206 Cost of incorporation;
220.127.116.11 Whether the corporation is public or private;
18.104.22.168 Size of the corporation
22.214.171.124.1 Small corporations incorporate in their home state.
126.96.36.199.2 Large corporations who operate in multiple states
generally choose to incorporate in Delaware
2.2.3 Delaware corporations pay taxes to Delaware.
2.2.4 If you are incorporated in one state but operate in another, you must file some kind
of paperwork in the second state and pay taxes there as well.
2.3 What law applies to corporations incorporated in one state and operating in another?
2.3.1 The Internal Affairs Doctrine says that for things relating to the internal affairs
of the corporation, like shareholder elections, the law of the state of incorporation
2.3.2 The law of the state of operation controls for external concerns like suits in tort or
3 Forming a Delaware Corporation
3.1 One forms a corporation by filing articles of incorporation with the secretary of State.
DGCL § 101(a).
3.2 Certain things must be in the articles of incorporation. DGCL § 102(a).
3.2.1 Name of the corporation, including a word or abbreviation signifying a
3.2.2 Address of the corporation and its registered agent in the state;
3.2.3 The nature of the corporation’s business;
188.8.131.52 Where a corporation operates outside of its business in the certificate of
incorporation it is operating ultra vires.
3.2.4 The number and types of stock that the corporation is authorized to issue, including
the privileges associates with each class of stock.
3.2.5 Names and addresses of incorporators;
3.2.6 Names and addresses of the directors who will act until the first shareholder’s
meeting, if not the incorporators.
3.3 Certain things may be in the articles of incorporation.
3.3.1 A provision creating, defining, limiting, or regulating the powers of the corporation,
the directors, or the shareholders;
3.3.2 A provision allowing shareholders first right to buy additional issues of stock;
3.3.3 A provision requiring a greater than majority vote for actions by the board of
directors or shareholders;
3.3.4 A provision limiting the duration of the corporation;
3.3.5 A provision waiving limited liability for shareholders;
3.3.6 A provision eliminating or limiting the personal liability of the directors to the
corporation or shareholders for breach of fiduciary duty, provided such provision
shall not eliminate or limit the liability of a director: (1) for breach of the director’s
duty of loyalty; (2) for acts or omissions not in good faith or which involve
intentional misconduct, or a knowing violation of law; 3) for unlawful payment of
dividends under DGCL § 174; or 4) for transactions in which the director obtained
improper personal benefit
4 Defective Incorporation
4.1 The majority view is that one who purports to act for a corporation not in existence shall
be jointly and severally liable. DGCL § 329.
4.1.1 Thompson & Green Machinery, CB 247. ) bought loader from ¶ when ) not
yet incorporated but ) thought he was incorporated. ¶ wins under this view.
4.2 The minority view is that one who deals with a defectively organized corporation as if it
were validly organized cannot subsequently challenge entity as defectively organized, this
is the common law doctrine of corporation by estoppel.
4.3 Under the MBCA § 2.04 only those acting as or on behalf of a corporation who know
there was no valid incorporation are jointly and severally liable for all liabilities created
while so acting. This protects shareholders.
4.4 Where a statute requires certain minimum requirements before a corporation can begin
business and the corporation fails to comply, the corporation will be liable for liabilities that
4.4.1 Sulpher Export v. Carribean Clipper, CB 253. State law required corporations
to comply with their articles of incorporation. ) failed to accumulate $1,000 of
capital before beginning business as required by )’s articles of incorporation. ¶
sued ) and ¶ wins; the directors & officers are liable because they failed to
5 Piercing the Corporate Veil
5.1 Sometimes, even though there is a valid corporation, there are reasons to hold
shareholders liable, this disregarding of the corporate entity is called Piercing the Corporate
5.2 No large publically held corporation has ever been pierced because the shareholders do
not exercise sufficient control over the corporation to warrant liability.
5.3 In smaller corporations, where shareholders exercise more control or are managers
themselves, the corporate entity is more likely to be disregarded.
5.4 Courts look at multiple factors when determining whether to pierce the corporate veil.
5.4.1 Contract v. Tort – Courts are less likely to pierce in contract cases because
contract creditors can choose with whom they deal; tort creditors are involuntary.
5.4.2 Corporate formalities – Did the corporation have meetings of shareholders and
directors, elect officers, etc? If so, it looks like a real corporation and piercing is
5.4.3 Domination and Control – When one shareholders dominates and controls the
management of a corporation it can lead to piercing, but standing alone this is
5.4.4 Siphoning of assets – When shareholders are siphoning funds from the corporation
then courts might pierce to get at the personal assets of the shareholders.
5.4.5 Commingling – When corporate and personal funds are commingled, it
demonstrates that they were acting as one and gives cause to pierce.
5.4.6 Undercapitalization – When the corporation is undercapitalized at inception, that
might give cause to pierce, but standing alone this is unlikely.
5.4.7 Target of Pierce – Courts are more likely to pierce when target is another business
entity than when the target is an individual (i.e. disregard subsidiary’s entity).
5.4.8 Active Shareholders – If shareholders are active in the business, then courts are
more likely to pierce.
5.4.9 Crime/Fraud – Where there is crime or fraud upon the corporation, courts are
likely to pierce the veil.
5.5.1 Perpetual Real Estate, CB 257. No siphoning of assets when money was
distributed before knowledge that suit might exist. If the distribution occurs after
knowledge of suit, it leads to finding of siphoning.
5.5.2 Kinney Shoe Corp., CB 261. ) formed two corporations: Industrial & Polan.
Industrial leased equipment from ¶, then subleased the equipment to Polan. ¶ sued
) because ) did not pay rent. ¶ sought to pierce corporation veil because
Industrial was undercapitalized and it did not comply with corporate formalities.
When a corporation is undercapitalized, fails to carry out corporation formalities,
and there is commingling of assets, the corporate veil will be pierced.
5.5.3 Wolkovsky v. Carlton, CB 266. ) formed many corporations that each own 1
or 2 taxis. The corporation held the minimum liability insurance required by law.
¶ injured by taxi and sued to pierce veil and go after ) personally. The court did
not pierce because the corporations complied with the statute. When a
corporation complies with statutory requirements for liability insurance,
undercapitalization is not a valid ground for piercing the veil. The proper recourse
is a change in the law, not piercing the veil.
5.5.4 Fletcher v. Atex, CB 271. Kodak was parent of Atex corporation ¶ attempted
to pierce corporation veil and get to Kodak. To pierce veil of a subsidiary and
reach the parent corporation’s assets: 1) the parent and subsidiary must act as a
single economic entity, and 2) there must be an overall element of unfairness
present. To determine whether the parent and subsidiary operate as single
economic entity the court must look to the traditional piercing of the veil factors.
Merely because parent and subsidiary share & coordinate operations, does not
mean they are acting as a single economic entity. Often the parent and subsidiary
act in ways that are most efficient even though they are acting like one business.
Arguments to show operated as single economic entity; and rebuttals (1) All
money goes to Kodak from Atex; this allows better management; (2) Kodak
approved Atex’s actions; corporations often ask shareholders about actions; (3)
Directors are the same for Kodak and Atex; overlapping directors is not sufficient;
(4) Atex was Kodak’s agent; no strong evidence of agency relationship. The court
found no evidence of unfairness to ¶ and did not pierce corporation veil.
5.5.5 Bartle v. Home Owners Cooperative, CB 279. Courts do not always pierce,
even when they should. Veterans formed cooperative and built homes through a
subsidiary. Subsidiary passed houses to the cooperative. Creditors sued
subsidiary who did not have any money and wanted to pierce the subsidiary and
reach the Cooperative’s assets. The court did not pierce here, probably because
it felt sympathetic toward the veterans, but the factors for piercing were present.
6 Successor Liability
6.1 Corporations acquire other corporations’ liabilities in several ways:
6.1.1 Merger – Surviving corporation acquires all assets and liabilities of constituent
corporations. DGCL § 259.
6.1.2 Acquisition of all outstanding shares – Acquiring corporation does not take
liabilities. of target corporation unless the new subsidiary is pierced.
6.1.3 Purchase of all of target’s assets – Acquirer takes on target’s liabilities if
184.108.40.206 Acquirer agrees explicitly or implicitly to take liabilities
220.127.116.11 Acquirer is continuation of target – Factors include:
18.104.22.168.1 Same business;
22.214.171.124.2 Same asset for same use (not sufficient in itself);
126.96.36.199.3 goodwill – how the public perceives your business;
188.8.131.52.4 Same owners or employees;
184.108.40.206.5 Same production facilities;
220.127.116.11.6 Are the names of the companies similar?
6.1.4 De facto merger – Merger in fact, but not explicit; do not comply with statutory
6.1.5 Transaction is a fraudulent effort to avoid liability.
6.1.6 Continuation of product line (minority view).
6.2.1 Tift v. Forage King, Inc., CB 286. ¶ was injured by Forage King’s tractor.
Forage King had sold all assets to ). ¶ wanted to hold ) liable. Here the court
found liability because it was engaged substantively as an identical organization
manufacturing the same product and was therefore a continuation of target
6.2.2 Anderson Lumber Co. v. Myers, CB 291. Third party corporation was indebted
to ¶. Before entry of judgment, third-party corporation formed similarly named
corporation and transferred its to the new corp at fair market value. The new
corporation performed same business as prior corporation the old corporation
could not pay its debts and creditor wanted to hold the successor liable. The mere
fact that a purchasing corporation is carrying on the same business as the selling
corporation is not sufficient to make the purchasing corporation liable for the debts
of the selling corporation. Here, the transaction is probably acceptable because
the new corporation bought the assets at fair market value and the creditor could
not have gotten more than fair market value for the assets.
7 Promoter Liability
7.1 The promoter is the person who founds and organizes the corporation.
7.2 Ideally corporate contracts are created entirely after incorporation, but sometimes some
liability must be incurred before incorporation.
7.3 Unlike defective corporation cases, both parties here know that there is not yet a
7.4 Corporate liability on promoters’ contracts.
18.104.22.168 A corporation is liable on promoters’ contract when it adopts the contract
22.214.171.124 Adoption is not retroactive like ratification and is a better approach to
corporation assuming liabilities created by a promoter.
126.96.36.199 Adoption occurs when the board passes a resolution or begins performing
7.4.2 An agency relationship does not work because there was no principal (the
corporation) at the time of contracting.
7.4.3 Ratification doesn’t work for the same reason, ratification operates ab initio, and
there was no corporation at that time.
7.4.4 Kridelbaugh, CB 295. The corporation is liable on promoter’s contract because
the board adopted the contract in a meeting. One director mentioned the contract,
but the other directors adopted the contract by silence and acquiescence
7.5 Promoters’ liability on promoters’ contracts after incorporation.
7.5.1 Promoters will generally be held personally liable on pre-formation contracts.
7.5.2 The contract can include a term that automatically creates a novation when the
corporation adopts the contract.
7.5.3 For the promoter to avoid liability he must:
188.8.131.52 Get the other party to agree to look elsewhere for satisfaction;
184.108.40.206.2 Original contract can include a term that causes a
novation when the corporation adopts the contract.
220.127.116.11 Don’t sign as an agent of the corporation; or
18.104.22.168 Don’t sign individually
22.214.171.124 Sherwood, CB 298. Creditor required that the contract show the
corporation as obligor and did not indicate that it intended to hold the
promoter liable. Creditor did not intend to perform until it received the
articles of incorporation. Here ) is not liable because the ¶ looked
toward the corporation, not the promoter for performance.
126.96.36.199 How, CB 301. Where the other party knows there is no corporation yet,
then the promoter is liable if the other party does not look to the
corporation for performance.
188.8.131.52 Stewart Realty, Where the promoter refuses to sign the contract in his
own name, but only signs as “corporation, by promoter” and the other
party knows that there is no corporation, the promoter is not liable
because the other party agreed to the contract knowing that the promoter
refused to be bound and must therefore have been looking to the
corporation for performance.
8 Accounting. See Accounting Handout.
9 Efficient Capital Market Hypothesis
9.1 ECMH holds that, at any time market prices are an unbiased forecast of future cash flows
that fully reflects all available information. If a market does reflect all information about the
corporation, the market is efficient
9.2 Three levels of efficiency:
9.2.1 Weak-form efficient – Current stock price reflects historic information. Almost
everyone believes this is true.
9.2.2 Semi-strong form efficient – Information about a corporation is included in stock
price very quickly. Most people believe this. Early birds will make money, but
most people will not make money on new information because the information is
incorporated into the stock price very quickly.
9.2.3 Strong-form efficient – The market price reflects all information about a
corporation, both publicly known and internally known by the corporation. No
one really believes this. It is rej
ht – Breach of Duty of Care through acts of subordinates.
13.3.1 The board will be liable to the corporation for losses resulting from the bad acts
of subordinates if:
184.108.40.206 1) The board knew or should have known that subordinates
were violating the law;
220.127.116.11 2) The board did not take any good faith actions to stop the
18.104.22.168 3) The board’s failure to monitor its subordinates proximately
caused the losses.
13.3.2 The directors need some sort of monitoring system to be informed, the nature of
which will vary depending on the attributes of the organization such as size.
13.4 Abolishing Director liability See Part 3.3.6 supra.
13.5.1 Shlensky v. Wrigley, CB 76. Wrigley refused to install lights at Wrigley field for
night baseball games. Shlensky sued, alleging that this was a breach of the duty
of care because it cost the Cubs money and all other MLB teams had lights. The
court concluded that Wrigley had legitimate business reasons for his choice and the
standard was not a reasonable company standard. Applying the Business
Judgment Rule, the court deferred to Wrigley’s decision because his inaction was
an informed, good faith judgment of what would be best for the corporation and
13.5.2 Miller v. AT&T, CB 79. A knowing violation of a criminal law, here illegal inkind
contributions, is not protected by the Business Judgment Rule. Plaintiff’s must
still prove that the losses incurred were caused by the violations to recover.
13.5.3 In re Caremark, CB 99. This is a derivative action that has been settled. The
court has to approve the settlement to dismiss the action. FRCP 23.1. That’s why
we’re here. Plaintiffs alleged that the directors violated their duty of care by
allowing employees to violate the law by paying for Medicare and Medicaid
referrals. Lower-level employees were the bad actors. We’re not going after the
corporation, but the Directors, to hold them personally liable. This is an action for
failure to monitor the directors’ subordinates. The trial court uses a “good faith”
test. The board of directors, to fulfill their function, must have relevant, timely
information to manage the company. There must be a system to gather such
information on behalf of the directors. The level of detail of this information is a
“business judgment.” What information is gathered is left to the discretion of the
board. They might collect information about our products, our competitors’
products. They will also collect information to prevent or correct prior problems.
The trial court lays out this test, (1) the directors knew or (2) should have known
that the company was violating the law; and (3) the directors took no steps in a
good faith effort to prevent or remedy that situation, and (4) such failure
proximately resulted in the losses that form the basis of the suit. (1) and (2) are
disjunctive with each other, either (1) or (2) must be present along with BOTH (3)
and (4). The company had a policy manual indicating that kickbacks were not
permitted. The company also performed internal audits and paid for external
audits. In addition, the company had training seminars where the policies were
reiterated. There is an oversight system in place and there is no indication that
there are problems. Being inactive in the business is not an excuse for a director.
The law sets a floor below which you cannot go.
13.5.4 Smith v. Van Gorkom, CB 83. The directors here were held liable for breaching
their duty of care by accepting an offer to buy the company that offered a 50%
premium to shareholders. Applying the gross negligence standard, the court held
that directors breached their duty of care by being uninformed because the board
failed to ask questions about the oral presentation of the offer; did not inquire as
to how the price was calculated; and failed to obtain a fairness opinion from an
14 Fiduciary Duties – Duty of Loyalty.
14.1 General Issues
14.1.1 Directors, officers, and controlling shareholders have a duty of loyalty to the
14.1.2 Questions about breach of the duty of loyalty arise when one who has such a duty
is interested in the transaction in question.
14.1.3 If a director is interested in a transaction, at common law the transaction was void;
today the transaction may be valid if the director can prove that the transaction
was fair to the corporation.
22.214.171.124 Once the plaintiff has shown that a director is interested, the
burden of proof shifts to the director to prove that the transaction
was fair to the corporation.
126.96.36.199 There is a range of reasonableness within which a transaction will
be considered fair; there is no magic number.
14.1.4 A transaction in which one or more of the directors is interested is not void if:
188.8.131.52 The material facts surrounding the transaction are disclosed or
known by directors and a majority of disinterested directors
approve the transaction;
184.108.40.206 The material facts surrounding the transactions are disclosed or
known to shareholders a majority of shareholders approve the
220.127.116.11 The interested director proves that the transaction is fair to the
corporation at the time it is authorized, approved, or ratified by
the board or shareholders. DGCL § 144.
18.104.22.168 DGCL §§ 144(a)(1) & (2) do not textually permit ratification, but
DGCL § 144(a)(3) does, so some argue on the principle of
inclusio unius est exclusio alterius that any ratified transaction
must still be proven to be fair.
14.1.5 Even if the director successfully raises a defense under DGCL § 144, the plaintiffs
can still show prevail by showing waste.
14.1.6 In cases where the shareholders approve a transaction, there are different views
as to what weight we should give that approval:
22.214.171.124 Complete defense to a charge of breach of duty. Cf. Van
Gorkom, CB 83.
126.96.36.199 Once shareholders approve, that shifts the test to one of waste.
Cf. Eliasberg, CB 156.
188.8.131.52 Shareholder approval shifts the burden of proof to the plaintiff to
show unfairness. Cf. Eliasberg, CB 156 (general view).
184.108.40.206 We should give no import to shareholder votes because they do
not vote or they vote how the directors want them to, etc.
14.1.7 Cookies Food Products, Inc. v. Lakes Warehouse Distributing, Inc., CB 115.
Majority shareholder served as a director and officer and paid himself a very high
salary. Minority shareholders sued alleging that the transaction was void for selfinterest.
A majority of the board was interested and there was no shareholder
approval, so fairness is the dispositive issue. Before the shareholder came aboard,
the company was underperforming, so his salary was ostensibly justified by his
special talents in the business and was therefore fair. Plaintiffs successfully proved
that the transaction was an interested one, but the defendant in this case was able
to show that the transaction was fair and therefore a valid transaction.
14.2 Problems resulting from Parent-Subsidiary relationships.
14.2.1 Problems arise in different contexts
220.127.116.11 1) Parent corporation creates a subsidiary that engages in a
separate business from parent. The subsidiary is created to
insulate the parent from liability. Parent corporation then sells the
subsidiary to another corporation that engages in the same
business as the sub.