ohio state university moritz college of...

OHIO CORPORATIONS PROFESSOR PAUL ROSE

OHIO STATE UNIVERSITY MORITZ COLLEGE OF LAW

INTRODUCTION

• Our task: to learn Ohio Corporations law in 8 easy steps. • Our topics:

1) Promoters and incorporation

2) Shareholder meetings, voting, and inspection rights

3) Shareholder lawsuits and duties

4) Directors’ voting and committees

5) Directors’ duties and indemnification

6) Stock and dividends

7) Mergers and dissenters’ rights

8) Close corporations and special corporate entities

CHAPTER 1: PROMOTERS AND INCORPORATION

A. Definition of Corporation

• A corporation is a separate _______________________________ that can sue and be sued, enter into contracts, and can last forever.

• A corporation’s shareholders have limited liability — they are not ________________________ responsible for the debts of the entity.

• A corporation can be formed quickly and at very little expense, but you must follow certain formalities.

B. Pre-Incorporation Transactions

• Who, if anyone, is responsible for contracts entered into before the corporation is actually formed?

1. Promoters

o A promoter is the person who persuades people to invest in a corporation he/she intends to form.

o A promoter generally is ___________________________ liable for any contracts entered into before the corporation exists.

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o The promoter is liable even after the corporation has been formed unless the corporation formally releases the promoter from responsibility (through a “______________________”).

o Promoter can limit his liability through an express agreement with an indemnification provision.

o Promoter will not be personally liable on a pre-incorporation contract if:

Contract specifically states that the promoter is acting only on behalf of the future corporation and assumes no ___________________________ liability;

The corporation is then formed ___________________________; and The corporation then __________________ that contract.

2. Corporation’s Liability

o The corporation is not liable for contracts entered into by the promoter, since there is no ___________________________ relationship between the promoter and corporation before the corporation exists.

o However, the corporation can be liable where the corporation __________________ the contract.

o Adoption takes place when the corporation ___________________________ the benefits of the transaction or gives an express or implied acceptance of liability for the debt (e.g., through board resolution after incorporation).

3. Incorporators

o The incorporator is the person who __________________ and files the articles of incorporation.

o The incorporator is not liable for pre-incorporation contracts.

C. Incorporation

• The key constitutional document is known as the articles of incorporation. • When the articles are filed with the Ohio Secretary of State and the fees are paid, a new

corporation is born. • What must the articles of incorporation include?

o The corporation’s ____________________________________

The name must include one of these magic words: “corporation,” “corp.,” “company,” “co.,” ____________________________________,” or “inc.”

The corporate name must distinguish the corporation from any other Ohio corporation or registered trade name.

o The address of the principal office of the corporation o The number of ________________________ the corporation is authorized to issue,

including par value, if any

Some businesses (e.g., banks, insurance companies) must issue shares with par value

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o If the corporation has any initial stated capital, the articles must state the ________________________ of that stated capital.

o Designated ________________________ in Ohio for service of process

Either a natural person who is an Ohio ________________________, or another Ohio business

o Corporate purpose is not required, and typically is not included.

Usually a corporation’s purpose is to “engage in any ________________________ activity.”

D. Bylaws

• After the articles of incorporation, the next most important document is the corporation’s ____________________________________.

o Not required to have bylaws, but nearly every corporation has them

Exam Tip 1: If you find the comparison helpful, think of the articles of incorporation as analogous to a constitution and bylaws as analogous to federal statutes; the articles control the general scope of corporate powers, and the bylaws control internal governance of the corporation to the extent they are not inconsistent with the articles.

• The bylaws contain the working rules for the corporation (e.g., how meetings are to be conducted, how directors are to be elected, the officers to be appointed, etc.).

E. Ultra Vires Acts

• A corporation used to need to state the precise nature or goal of its business in its articles; acts deviating from that stated purpose were considered ultra vires acts (i.e., outside the corporation’s powers, and potentially unenforceable).

• The ultra vires doctrine is much less important today because corporations are typically set up to engage in “any ________________________ activity.”

• If the corporation acts outside its stated purpose, an ultra vires action can be brought by:

o A shareholder filing suit to ________________________ the corporation’s ultra vires action; o The corporation taking action against a director, officer, or ___________________________

of the corporation who engages in such action; and o A state initiating a proceeding against the corporation.

F. Defective Corporations

• When the proper requirements are met for forming a corporation, it is called a de jure corporation.

• If the requirements are not met, but the corporation does business as though it had complied, either the incorporator or corporation may still be liable.


o Liability under a defective corporation for obligations will usually depend on whether you made a ____________________________________ effort to incorporate.

If you did not act in good faith, you will be personally liable for all obligations incurred in the name of the would-be corporation.

If you did act in good faith, the would-be corporation may be treated as if it were a de jure corporation, and you may not be personally liable in two circumstances:

• May be considered a de facto corporation if the owner:

o Has made a colorable good-faith effort to comply with the incorporation requirements of the state; and

o Operates the business as a corporation without ________________________ that these requirements have not been met.

• May be treated as a corporation by estoppel

o A person who deals with an entity as if it were a corporation is estopped from denying its existence and thereby prevented from seeking the ____________________________________ liability of the business owner.

Example 1: A nurse signed a non-compete agreement while working for a healthcare organization as an independent contractor. After she left her job and sought new work elsewhere in violation of her non-compete agreement, the healthcare organization sought to enforce its agreement. The court discovered that the healthcare organization was a limited liability corporation that had never properly incorporated as a de jure corporation. Additionally, the healthcare organization did not operate in good faith as a de facto corporation. However, because the nurse had dealt with the organization as if it were a corporation, the organization was a corporation by estoppel as to her, and she could not deny its corporate existence to avoid the non-compete agreement.

CHAPTER 2: SHAREHOLDER MEETINGS, VOTING, AND INSPECTION RIGHTS

A. Introduction

• Shareholders’ most important roles are to

o Elect the ____________________________________ who oversee the corporation and select officers who run it on a day to day basis, and

o Vote on ____________________________________ changes.

• In this section we’ll consider three simple but very important issues:

o When do the shareholders vote? o What do they vote on, and what is the required vote? o What right do they have to inspect corporate records?


B. When Do Shareholders Vote?

1. Annual Meetings

o Most shareholder voting takes place at the ________________________ meeting. o The corporation is ________________________ to hold an annual meeting once a year to:

Elect ____________________________________; Address any other shareholder business, such as shareholder proposals; and/or Vote on ____________________________________ compensation and selection of

auditors.

o Generally, the time and place of the meeting is specified in the articles or regulations.

If not stated, the meeting is to be held on the first ________________________ of the ________________________ month after the close of the corporation’s fiscal year.

2. Special Meetings

o A special meeting can be called by:

The Board of Directors; The President; The Chairperson of the Board; Shareholders who control at least _______% of the corporation’s voting shares (unless

the articles specify a smaller or larger proportion, so long as it’s not greater than 50%); Officers or others, if provided for in the bylaws.

o To call a special meeting, a written request must be delivered ________________________ or by _________________________________ to the president or secretary of the company.

o If notice is not given to the shareholders after that point, the person requesting the special meeting may set the date and send notice.

3. Location

o Meetings are held at the corporation’s ________________________ offices, unless the bylaws specify another location.

o The meetings can also be held via Internet.

4. Notice

o Shareholders must be given notice of either type of meeting no fewer than ____________ days and no greater than ____________ days prior to the meeting.

o A shareholder can ________________________ the notice either in writing or by showing up at the meeting and not protesting prior to the start of the meeting.


5. Record Date

o To determine which shareholders vote, the directors must fix a ____________________________________ date, unless the articles have provided for one.

o Typically, the record date cannot be earlier than the date the directors are meeting to set the date (i.e., you can’t backdate the record date) or more than ____________ days before the shareholder meeting.

o Only the holders of record of shares as of that date can vote.

Example 2: Our Corp’s record date is 50 days before its annual meeting. 120 days before the meeting, A sold her Our Corp stock to B. 40 days before the meeting, B sold the stock to C. 10 days before the meeting, C sold the stock to D, and D holds the stock at the time of the meeting. Which shareholder is entitled to vote?

Answer: ____________

6. Unanimous Consent

o In addition to acting at an annual or special meeting, shareholders can act by unanimous consent, unless the articles or bylaws take this right away.

C. How Do Shareholders Vote, and on What?

1. In General

o Shareholders vote on (i) the election of directors, (ii) fundamental changes proposed by the directors, and (iii) any other issues submitted for a vote by the directors

o Fundamental changes on which shareholders MUST vote include:

________________________; ________________________ exchanges; ____________________________________to the articles of incorporation, including:

• Changes that affect the legal or economic rights of the shareholders; or • Changes that substantially alter the purpose of the corporation (e.g., change from a

for profit corporation to a nonprofit corporation);

Sale of all or substantially all of the corporation’s ________________________; and ____________________________________ of the company.

2. Shareholder Approval

a. Quorum

Shareholders cannot take any formal action unless a ________________________ of shareholders is present.


Very easy in Ohio: Unless the bylaws specify a different number, the shareholders ________________________ at the meeting (in person, by proxy, or by electronic communication) constitute a quorum.

b. Shareholder proxies

Do not have to physically attend the meeting to be “present” to vote Shareholders permitted to authorize another person, a proxy, in writing to vote on

shareholder’s behalf

• Proxies are often the directors of the corporation.

Proxy ballot must be sent to the ________________________ of the corporation prior to the meeting.

Proxies can give broad voting authority, but typically authorize voting at certain meetings and on certain issues.

c. Necessary vote

For fundamental changes, the default rule requires a “yes” vote by of 2/3 of the shares entitled to vote for these fundamental changes, although the articles may generally allow for ____________________________________ approval.

However, where there are separate classes of shares, each class of stock may be required to ____________________________________ approve of the issue.

Example 3: Suppose Our Corp has 100,000 shares issued and outstanding. 70,000 shares are voted. 40,000 shares vote in favor of a proposed merger, and 30,000 vote against. Is the merger approved?

Answer: ____________—we need a 2/3 majority of the shares entitled to vote to be voted in favor of the merger (more than 66,666) to approve the deal.

d. Voting power

Generally, each share of stock is entitled to ____________________________________. However, a corporation, through its articles of incorporation, can create classes of stock

that have greater voting power (e.g., each share is entitled to five votes) or classes of stock that cannot vote (i.e., non-voting stock).

Example 4: Facebook filed for an initial public offering and had two classes of shares, Class A (being sold to public investors) and Class B (stock that Zuckerberg and other specific people own). Class A gets 1 vote per share, Class B gets 10 votes per share.

3. Cumulative Voting to Elect Directors

o Unless the articles provide otherwise, shareholders in Ohio are entitled to ____________________________________ their votes for directors.


o Rather than having separate votes for each directorial slot, shareholders are given a number of votes equal to the number of ________________________ multiplied by the number of ____________________________________ being voted on.

o Shareholders can then stack their votes on one or a small number of candidates if they wish.

The purpose of cumulative voting is to make it easier for minority shareholders to elect at least one director.

Example 5: Suppose A owns 30 shares of Our Corp. stock, B owns 70 shares, and Our Corp. has three directors. Can A elect a director of her choice under cumulative voting?

Answer: With cumulative voting, A can elect at least one director by casting all of her ____________ votes (i.e., 30 votes per director x 3 directors) for one director. B has 210 votes, and so if the votes were spread evenly among B’s candidates, B would only have ____________ votes per director. [So B will have two directors and A will have one director.]

D. Shareholder Inspection Rights

• Shareholders have very generous inspection rights in Ohio.

o These rights are available both to ____________________________________ holders and their ________________________.

• Shareholders have the right to inspect the corporation’s books and records, or its list of shareholders for any ____________________________________ purpose.

• The right to inspect can only be denied if the shareholder does not have a purpose that is ____________________________________________________________ to her interest as a shareholder.

Example 6: If the shareholder seeks to harass corporate officials or acquire corporate secrets, her right to inspect can be denied for lack of proper purpose.

CHAPTER 3: SHAREHOLDER LAWSUITS AND DUTIES

A. Introduction

• In addition to their voting rights, shareholders have the right to ____________ directors to enforce the directors’ fiduciary duties.

• It is important to note the two risks a shareholder faces, especially those who control the corporation.


B. Shareholder Litigation

1. Direct Suits v. Derivative Suits

o Shareholders sue directly if they can. o In general, an action that principally harms the shareholder is a

________________________ action while an action that harms the corporation as an entity is a ________________________ suit.

Shareholder suits arguing that their voting or dividend rights have been interfered with, or that challenges a merger, are usually direct.

An allegation that directors mismanaged the corporation is usually derivative.

Example 7: If shareholder alleges that a decision by Our Corp’s directors to start a new line of business has been disastrous for Our Corp, would the suit be direct or derivative?

Answer: It would be ________________________ because it goes to a general harm to the corporation and not against a particular shareholder.

Example 8: What if Our Corp has refused to allow one of its shareholders the right to inspect its books and records?

Answer: This would be a ________________________ suit, since it is designed to enforce the shareholder’s rights.

2. Direct Suits

o In direct suits, the shareholder sues in her ________________________ and any recovery comes directly to her.

o A shareholder can sue directly if:

She is enforcing her rights as a ________________________________ (e.g., alleging voting rights have been interfered with); or

The corporation has harmed her in some other capacity (e.g., she was hit by one of corporation’s trucks).

3. Derivative Actions

o In a derivative action, the cause of action belongs to the ____________________________ and the shareholder is suing on the corporation’s behalf.

o Derivative actions have several distinctive requirements and effects:

Standing: The shareholder must have been a shareholder at the time of the harm or the shares must have devolved on the shareholder by operation of law.

�Demand: Shareholders are generally required to make “________________________” on the directors before they can bring suit.


• “Demand” means that shareholders must first ask the ________________________ to bring suit, before they can bring suit themselves.

Demand futility: Most states, including Ohio, allow shareholders to sue without first making demand upon the board if demand would be futile.

• Factors for determining futility include:

o Whether the directors are ____________________________________ and independent; and

o Whether the transaction was the product of a valid exercise of ________________________________________________.

o The Board’s rejection of demand is tested by the business judgment rule. o In a derivative suit, the recovery goes to the ____________________________________,

rather than straight to the shareholders. o Attorney’s fees

If the litigation produces a “________________________________________________” to the corporation, the plaintiffs’ attorneys are entitled to payment of their fees by the corporation.

Exam Tip 2: This is an important exception to the usual rule that each side in a lawsuit pays their own attorneys.

C. Federal Securities Claims

1. 10b-5 Anti-Fraud Action

o Most common federal securities law claim o 10b-5 claims for “fraud on the market” must meet the following standards:

Jurisdictional nexus: The alleged fraud must have involved an instrumentality of ________________________________________________ (e-mail, phone, etc.).

Transactional nexus: The alleged fraud must be “in connection with” the ________________________ or ________________________ of a security.

Complaint must allege a ________________________ misstatement or omission by defendant

Defendant must have acted with ________________________ (intentionally or recklessly)

Plaintiff must have ________________________ on the defendant’s conduct (reliance may be presumed in some cases, such as in fraud-on-the-market cases).

Plaintiff must show that he suffered ________________________ as a consequence of the defendant’s conduct.

o Under the “disclose or abstain” rule, 10b-5 is also used in cases of insider trading.


o 10b-5 prohibits trading on the basis of insider knowledge by:

Company insiders; Constructive insiders (such as outside ________________________ or accountants

working with the company); People who receive “____________” from insiders (“tippees”); and “Misappropriators”—someone who, while not an insider of the corporation,

nevertheless owes a duty to keep company information confidential

Example 9: If you are a constructive insider and give your roommate material insider knowledge with the intent that the roommate use the information in trading stocks, and the roommate does, you are both liable under 10b-5.

Example 10: If you are a constructive insider and give your roommate material insider knowledge on accident while complaining about work, unaware that it could be used in trading stocks, you are not liable. The roommate will be liable under 10b-5 as a misappropriator if he trades stock on the basis of this information.

Example 11: If you are a constructive insider and give your roommate material insider knowledge on accident while complaining about work. Neither of you makes a trade, but your neighbor overhears the conversation and trades based on the insider knowledge. No one is liable under 10b-5 on these facts.

2. Insider Trading and Section 16 of the Securities Exchange Act

o Section 16 applies to corporate directors, officers (e.g., president, vice-president, secretary, treasurer, or comptroller), and shareholders who hold more than ____________% of any class of stock.

o Section 16 imposes two requirements:

Reporting of changes in stock ownership; and The “________________________ profit” rule: During any six-month period, a

corporate insider who both buys and sells his corporation’s stock is liable to the corporation for any ________________________ made.

o Profits are computed by matching the ________________________ sale price with the ________________________ purchase price, then the next highest sale price with the next lowest purchase price, and so on, during the six-month period.

Any loss is not taken into account, and all shares are matched with other shares only once.

Example 12: On January 1st, President sells 200 shares of ABC Corporation’s stock for $500 each that she had purchased several years before for $100 each. On May 1st, President purchases 300 shares of stock for $400 each. President


has a short swing profit of $20,000 (i.e., the sale of 200 shares at $500 each, less purchase of 200 shares at $400 each).

D. Liability of Shareholders: Piercing Corporate Veil

• The general rule is that shareholders have ____________________________________:

o Shareholders are generally not liable for the ____________ of the corporation. o This is a key attribute of corporations.

• Veil-piercing exception: If shareholders have abused the corporate form, creditors can seek to hold a shareholder or shareholders responsible for a ____________.

• Courts are generally ________________________ to pierce the corporate veil. Their analysis whether to do so is generally very fact intensive. A few common factors:

o The shareholder ____________________________________ or dominated the corporation so that the corporation had no separate mind, will, or existence of its own;

o The control is exercised to commit a ________________________ or illegal act; and o Shareholder’s wrong caused injury or unjust loss to the plaintiff.

Example 13: Shareholder sets up Pool Company as a private pool. Pool Company has no real assets—it doesn’t even own the pool—and it has not held board or shareholder meetings. If Plaintiff is seriously injured in Pool Company’s pool, and obtains a judgment, can she pierce the veil and hold Shareholder responsible?

Answer: ____________, unless there is some evidence of wrongdoing on the part of Pool Company.

E. Duties to Other Shareholders

• Shareholders generally do not owe a duty to their fellow shareholders or to the corporation. • Exception: A ____________________________________ shareholder:

o Owes a duty not to sell her stock to a ________________________; and o Owes a general duty in connection with

________________________________________________ (e.g., if the controlling shareholder is seeking to unfairly eliminate other shareholders from the corporation, or receiving a distribution denied to the other shareholders).

• Need not hold more than 50% of the stock to be a controlling shareholder; if the corporation’s stock is widely held, a shareholder with much less than 51% may have effective control.

• Exception for Close Corporations: In corporations with just a few shareholders, shareholders do owe a ________________________ duty to deal with one another in ____________________________________.


CHAPTER 4: DIRECTORS’ VOTING AND COMMITTEES

A. Introduction

• The board of directors manages and directs the management of the corporation’s business and affairs.

• This means appointing the officers who run the business on a day to day basis, overseeing the officers, and making the high level corporate decisions.

B. Director Basics

1. Number and Qualifications

o The board can have as few as ____________ director, but Ohio assumes ____________ if the articles are silent.

o Can be any ________________________ person

Example 14: Could Google serve as a director of Our Corp?

Answer: ____________—natural persons only

2. Term and Selection

o Directors ordinarily serve for a one-year term.

Exception: A “____________________________________” or “staggered” board of directors, where each class serves for several years (often 3 years), with the term of one class ending each year.

Example 15: Our Corp’s articles of incorporation provide for three classes of directors, each serving a three-year term. Directors of class A are elected in 2017, class B in 2018, and class C in 2019. The terms of class A directors expire in 2020 and another election will occur. This repeats so that one class is elected each year.

o Directors may resign at any time by giving ________________________ to the corporation or to the board or chair of the board.

o Director vacancies may be filled by a ________________________ vote of the remaining directors (even if the remaining directors do not constitute a quorum), or by a vote of the shareholders.

Exam Tip 3: Do not forget that directors may be elected by either straight or cumulative voting.

C. Removal and Replacement

1. Removal

o Unless the bylaws say otherwise, shareholders generally can remove directors with or without ________________________ before the end of the director’s term.


o Three exceptions:

Directors on a staggered or classified board can only be removed ____________________________________;

Directors elected by a particular class of ________________________ can only be removed by that class; and

Directors elected by ____________________________________ voting cannot be removed if votes sufficient to elect the director are cast against removal.

2. Replacement

Either the shareholders or the directors can replace a director if: o There is a ________________________; or o The ____________ of the board has been increased.

Example 16: Raider buys stock of Our Corp and wants to call a special meeting to replace Our Corp’s directors with Raider’s friends. If Our Corp has a classified board, with three classes of directors, can Raider replace the directors?

Answer: ____________- Raider can only remove classified directors for cause, and in director elections, in any given year, Raider could only replace 1/3 of the directors (one class of directors), which is the very reason why companies put in place classified boards!

D. Board Meetings

• Notice requirements for directors meetings are less formal than with shareholder meetings. • Notice of the ____________ and ____________ of each meeting of the directors must be given

to each director at least ____________ days before the meeting. • If a director signs a waiver or appears at the meeting, she waives notice. • A director need not be physically present at the meeting, and meetings can take place

__________________________________ (e.g., via Skype).

E. Voting Requirements

1. Quorums

o A quorum of directors must be present (physically or electronically) for any directorial decisions to be ________________________.

o Unless the articles or bylaws set a higher or lower number, Ohio sets the quorum at a ________________________ of all directors in office.

o If the numbers of directors falls below a quorum during the meeting, the quorum is lost. o Directors ________________________ be represented by a proxy.

2. Votes Required

o Unless the articles or bylaws set a higher number, a ________________________ of the directors who cast a vote on the issue is required for approval of an action.


Example 17: Our Corp has 9 directors. Four are present at a meeting, and they vote 3 to 1 in favor of an action. Has the action been approved?

Answer: ____________—no quorum was present. You need at least 5 directors present at the meeting, with 3 voting in favor.

3. Voting Agreements

o An agreement between directors as to how to vote is generally ____________________________________.

o Each director is expected to exercise his/her own independent business judgment.

F. Director Dissent

• If a director wishes to avoid potential liability for a board decision from which she dissented, the director must:

o Promptly file a ________________________ dissent during the meeting or within a ________________________________________________ after the meeting.

o Ensure her dissent is noted in the meeting’s minutes or not vote in favor of the action; and o Deliver written notice of her dissent to the presiding officer before its adjournment, or to

the corporation immediately subsequent to the meeting.

G. Committees

• Directors can ________________________ many (but not all) of their responsibilities to committee if a majority of all the directors vote to establish the committee and to appoint a director to the committee.

• Committees are not permitted to make certain major decisions on behalf of the board, such as:

o Declaring distributions; o Recommending actions to shareholders that require shareholder approval; o Creating or fulfilling board vacancies; and o Adopting, repealing or amending ________________________.

• Sarbanes-Oxley Act and Related Reforms

o The Sarbanes-Oxley Act (2002) requires an audit committee for publicly held firms to supervise outside auditors reviewing financial statements.

o Additionally, firms listed on a stock exchange must also have:

A nominating committee to decide which directors the corporation will propose for election; and

A compensation committee to decide the compensation for officers and other directors.

o The directors on these committees must be ___________________________________ (not employed or otherwise compensated by the corporation), subject to limited exceptions.


CHAPTER 5: DIRECTOR AND OFFICER DUTIES AND INDEMNIFICATION

A. Introduction

• This is a popular chapter on the bar exam. • Directors owe two basic duties to the corporation:

o The duty of ________________________; and o The duty of ________________________.

B. Director Duty of Care

1. In General

o The duty of care applies to board decisions in which a director does not have a self-interest. o Distinguish between “________________________” and “____________” (i.e., situations

where the board doesn’t do anything versus decisions the board actually makes)

2. Omissions and the Prudent Person Standard

Omissions are determined using the basic “____________________________________” Standard:

o Directors have the responsibility to act with the care of an ordinarily prudent person in a like position and similar ____________________________________.

o If directors have ____________________________________, they are required to make use of these skills.

Example 18: Elderly Mother is a director of Our Corp. If she looked at any of Our Corp’s financial statements, she would have seen that her sons, the principal officers of Our Corp have been stealing money. Has Elderly Mother violated her duty of care?

Answer: ____________. The court in that case said that she had violated her duty of care in not reviewing financial statements.

3. Acts by Directors, Reliance, and the Business Judgment Rule

o When a shareholder is challenging an act of the director, two additional doctrines are applied that help protect the director: reliance and the business judgment rule.

o Reliance: A director is entitled to rely on ________________________ and reports provided by:

Officers and other employees; Outside ________________________ they may hire, such as attorneys or investment

bankers; and Committees of the board.


o Business judgment rule: If a director actually makes a decision and doesn’t have a ________________________ interest in the decision, courts apply the business judgment rule.

There is a rebuttable presumption that the director ________________________ believed his actions were in the best interests of the corporation.

The presumption is rebuttable by ____________________________________ evidence, and directors will be found liable for breaching their duty of care, under the following circumstances:

• Failure to ________________________:

o The director did not adequately inform herself before approving the decision; o There was a sustained failure by the director to devote attention to an ongoing

________________________ of the business and affairs of the corporation; or o The director failed to timely investigate a matter of significant

________________________ concern after being alerted in a manner that would have caused a reasonably ________________________ director to do so.

• Self-interest: The director acted disloyally. • Lack of _____________________________: The director did not act in good faith.

Exam Tip 4: Courts will rarely find liability if the director fully informed herself. If you are asked a question on a business judgment issue, the answer will often depend on the carefulness of the process (or lack thereof) the board undertook in making the decision.

Example 19: On Friday night, Their Corp offers to merge with Our Corp, and to pay Our Corp shareholders $32 per share, but Our Corp’s directors must decide by 6pm Saturday. The current price of Our Corp’s shares is $30 per share. Saturday afternoon is Our Corp’s firm picnic. The directors meet for thirty minutes at the start of the picnic to discuss the merger and vote to approve it (pending the subsequent shareholder vote). They sign the proposed merger agreement during the picnic. Have they violated their duty of care?

Answer: ____________. Given such egregious (and hopefully improbable) facts, the answer would likely be that they had violated their duty of care by failing to fully inform themselves.

4. Ohio’s Constituency Statute

In determining what the director reasonably believes to be in the best interest of the corporation, the director must consider the interests of ________________________________ and, in his discretion, may consider the interests of:

o Employees, suppliers, ________________________, and customers of the corporation; o State and national ________________________;


o Community and societal interests; and o Long- and short-term interests of the corporation and shareholders.

C. Director Duty of Loyalty

1. Introduction

o The duty of loyalty encompasses three separate duties of a director. o The common theme is that a director or board must not put personal interests ahead of

the interests of the corporation.

2. Self-dealing Transactions

o Definition: A self-dealing transaction is a corporate transaction in which the director (or a relative of the director) has a ____________________________________ interest.

Most common example is a contract between the corporation and either the director or a business in which the director has a stake

o Rule: The interested director is required to disclose her interest to the board.

In the absence of disclosure, the director will be found to have breached her duty unless she can show that the transaction was ____________ to the corporation.

o Safe Harbors: In Ohio, a self-interested transaction may be upheld if:

It is disclosed to, and approved by, a ________________________ of the board’s non-interested directors;

It is disclosed to and approved by a majority of ________________________________ without a conflicting interest; or

If it is ____________ as to the corporation as of the time it occurred.

o In some jurisdictions, satisfying a safe harbor is not a complete defense, but instead is seen as shifting the ____________________________________ to the plaintiff to show that the transaction is unfair.

Example 20: Director, a director of Our Corp, offers to lease his warehouse to Our Corp for $120,000/year. The going rate is actually $100,000/year. A majority of Our Corp’s disinterested directors approve the lease. Can Shareholder successfully challenge the lease?

Answer: Typically, the answer would be ____________, unless the plaintiff can show that the directors who approved the transaction were not really disinterested.

o Remedy: The usual remedy for a breach is to ________________________ or ________________________ the transaction, or to require the interested director to disgorge her excess benefit.


3. Corporate Opportunity Doctrine

o Unlike self-dealing, the director does not enter into a transaction with the corporation, but instead takes a corporate opportunity for herself.

o Rule: A director is expected to first offer the opportunity to the ____________________________________, and pursue the opportunity only if a ____________________________________ board rejects it (uninterested or unable to pursue the opportunity.)

o If the director simply takes the opportunity without presenting it to the corporation, the key question is whether it was actually a corporate opportunity.

o Three tests to determine if the opportunity relates to the corporate business are:

The ________________________ Test: Is the transaction intrinsically unfair to the corporation?

The Interest or ________________________ Test: Would the company expect to, or have an interest in, taking the opportunity? and

The ________________________________________________ Test (largely adopted in OH): Is the opportunity in the company’s field? Four factors:

• Knowledge of the investment or business opportunity was gained by the director in his ________________________ capacity;

• The opportunity was within the ____________ of the corporation’s business; • The opportunity would have been ____________________________________ to

the corporation; and • The corporation would have been able to ____________________ the opportunity.

Example 21: Director, a director of Golf Club Inc. is playing golf on Golf Club’s course with Seller, who owns an adjoining property. Seller suggests that Golf Club may wish to buy the property to expand the golf course. Director buys the property herself, without telling the other directors. Has Director violated the corporate opportunity doctrine?

Answer: ____________, since the golf course may have been in a position to develop the land—the director didn’t give the other directors the chance to consider the matter.

4. Competition with the Corporation

o A director may also be found liable for breaching her duty of loyalty if she engages in a business that competes with the corporation.

Example 22: If Director started a new golf course in the same community as Golf Club’s course, she may have violated her duty not to compete with Golf Club.


D. Indemnification

• Indemnification is the corporation’s promise to pay the costs of a director’s defense of litigation against her.

• There are two types of indemnification:

o ________________________ indemnification: The corporation is required to pay the costs of defense if the director successfully defends the case.

o ________________________ indemnification: The corporation may, but is not required to, indemnify a director for the costs of an ____________________________________ suit if the director:

Acted in good faith, with the ____________________________________ belief her actions were not opposed to those of the corporation; and

In a ________________________ case, the director did not have reasonable cause to believe the conduct was unlawful.

• The corporation cannot indemnify against liability for receipt of an improper ____________________________________ benefit.

• A corporation usually buys insurance indemnifying the director against the costs and any liability from litigation.

E. Officers

• Officers are selected by the directors to run the company on a day-to-day basis. • Ohio requires that every corporation have at least a ________________________, a

________________________, and a ________________________. • An officer’s authority to make decisions is either actual or apparent authority.

o ________________________ authority is implied by the conduct of the board or expressly stated in the articles, bylaws or a resolution of the board, and looks at the officer’s reasonable beliefs about the scope of the officer’s authority.

o ________________________ authority is based on the expectation of authority a third person would reasonably think the officer has.

• Officers have the same duties as directors – namely the duty of care, the duty of loyalty, and the obligation to act in good faith.

o However, most fiduciary duty litigation targets directors, not officers.

• An officer is entitled to ____________________________________ to the same extent, and subject to the same restrictions, as a corporate director.

• The corporation will usually also buy insurance indemnifying the officer against the costs and any liability from litigation.


CHAPTER 6: STOCK AND DIVIDEND DISTRIBUTIONS

A. Stock Basics

1. Definition

o A share of stock provides control rights and a kind of ownership interest. o Most corporations have only one ____________ of stock, but they can have as many as they

want.

2. Stock v. Debt

o Stockholders are entitled to what is left over after the ________________________ of a corporation are paid.

o Stockholders are around forever (in theory); debt holders are only involved until they are repaid.

o Debt obligations may be either ____________________________________ or ____________________________________.

3. Stock Certificates

o Stock is traditionally evidenced by a stock ____________________________________, although this may be held by a broker or depository institution.

Some companies never issue physical stock certificates.

o Stock ordinarily can be freely transferred.

In Ohio, any restriction on transfer must be ________________________ on the stock certificate itself.

B. Issuance of Stock

1. Authorized, Issued, and Outstanding Shares

o The maximum number of shares a corporation wishes to “authorize” must be set in the articles of incorporation.

If the directors want to sell more than this, they must propose an ____________________________________ to the articles.

o “Issued” stock is stock that has been sold and sent out to the investor. o Stock that has been authorized, issued and sold to investors is “outstanding”.

Example 23: If a corporation’s articles authorize 1 million shares of stock, and it has sold 600,000 shares to the public, the 600,000 shares would be known as authorized, issued, and outstanding. The 400,000 shares not yet sold would be authorized but unissued.

o “________________________ stock” shares are active, authorized shares that were either acquired by the corporation in a re-purchase from shareholders, or paid as a


____________________________________ on the existing treasury shares of the corporation.

o To “retire” a share means to buy stock back and then cancel it—it has no _______________ and is not reissued (it returns to the status of authorized but unissued stock).

o “Unauthorized” shares are shares not authorized in the articles of incorporation, and are void.

Any amount paid for unauthorized shares by their purchaser is ____________________________________.

2. Consideration for Stock

o Stock can be sold for almost any consideration a corporation and the buyer agree on.

This includes cash, property, and for past ________________________ performed.

o Stock sold in exchange for a promise of future services is permissible, but the stock is not considered paid for until after completion of the services.

Example 24: Could Our Corp sell me stock of the corporation in return for my promise to provide future corporate law consulting services to the corporation?

Answer: ____________, but the stock would not be considered fully paid until the services were performed.

3. Par Value

o Definition: “Par value” is the ____________________________________ price for which the stock can be sold by the corporation.

o Par only applies when the stock is ________________________ by the corporation; it does not apply if one shareholder sells to another.

o If a corporation wishes to set a par value on its stock, the par value must be specified in the ________________________ of incorporation.

o Ohio no longer requires that stock have a par value, but some companies still use it.

Example 25: Suppose that a corporation’s stock has a par value of $5/share, and the corporation sells 10 shares to Buyer for a total of $20. This sale violates the par value requirement, because the minimum sale price should have been $50, or $5/share.

o When a corporation does not receive consideration equal to at least par value, the stock is characterized as “________________________” stock.

Every shareholder, the original and all subsequent, of watered stock is ________________________ to the corporation’s creditors for the difference between the par value of the stock and the amount paid for the stock.


Exception: The shareholder acquired the shares without ________________________ knowledge that the shares were not fully paid for when initially purchased.

4. Stock Subscriptions

o In the time between when the articles are filed, but before the directors are elected, people may subscribe to purchase stock from the corporation for when it comes into existence.

o Absent agreement, the subscriber does not have the unilateral right to _________________ a subscription.

5. Preemptive Rights

o A preemptive right is the right to buy enough stock to maintain your ownership ______________________________ in the corporation if the corporation sells more stock.

Example 26: A and B, the only shareholders of Our Corp, each own 50 shares of stock. The board of directors of Our Corp authorizes the issuance of another 20 shares of stock. With preemptive rights, A and B would each be entitled to purchase 10 additional shares of stock and would retain a 50% ownership interest in the corporation. Without such rights, either A or B could become the controlling owner of Our Corp by purchasing at least 11 additional shares of the new stock offering.

o Opting-In vs. Opting-Out

For corporations formed before March 17, 2000, _______________________________ rights are given to shareholders of any class with unlimited dividend or liquidation rights unless the articles of incorporation state otherwise.

Editor's Note 1: Professor Rose misreads this date slightly the first time he reads the rule. Note that this rule applies to corporations formed before March 17, 2000, not May.

For corporations formed after that date, shareholders have preemptive rights only if the ________________________ state these rights are given.

6. Voting Agreements and Voting Trusts

o Shareholders, not directors, are permitted to enter into voting pools and trusts. o Voting pools are agreements to vote according to the rules of the collective pool. o Shareholders are also permitted to transfer their stock to a voting trust.

In Ohio, voting trusts are limited to a ____________ year term, but can be renewed.

7. Federal Securities Act of 1933

o A corporation that issues stock or other securities may be required to ________________________ the security with the SEC.


o There are exemptions for sales to certain accredited investors, including:

Companies with assets exceeding $5,000,000 Individuals with a net worth exceeding $1,000,000

C. Dividend Distributions

1. Introduction

o Distributions can be made to shareholders two ways:

Paying out a dividend (cash payment or stock); or Buying stock from shareholders.

o Unless restricted by the bylaws, directors have ________________________ discretion to make distributions.

2. Limitation on Discretion

o Ohio does not allow a company to pay dividends if it is insolvent or the distribution would cause it to be insolvent.

3. Director Liability on Improper Distributions

Example 27: Desperate Directors make a dividend distribution hoping to quiet a shareholder revolt at a time when Our Corp. is insolvent (about to file for bankruptcy). Are Desperate Directors personally liable for this improper dividend?

o If a director violated her duty of care or loyalty in approving the dividend, she is ________________________ liable for any amount above the lawful ____________________________________ amount.

o Recoupment: A director is entitled to ____________________________________ from:

Other directors who have also violated their duties; and The excess amount received by a shareholder who ______________________________

accepted an unlawful distribution.

CHAPTER 7: MERGERS, DISSENTER RIGHTS, AND DISSOLUTION

A. Introduction

• A merger is considered a fundamental change in the corporation.

o Fundamental changes must be both proposed by ________________________ and voted upon by a ________________________ of all shares.

• Mergers also give rise to a shareholder protection known as _____________________________ rights (in other states these are called “appraisal” rights).


B. Mergers

1. Basics

o A merger is the combination of two corporations, with only one of the corporations ________________________.

o The surviving corporation assumes the assets and ________________________ of the corporation it acquires.

o A consolidation is similar to a merger, except that ________________________ corporation survives; a new corporation is created instead.

Example 28: Merger example: In 2008 Bank of America began the process of merging with Merrill Lynch. In the merger Bank of America acquired Merrill Lynch, and Merrill Lynch as a separate entity ceased to exist. Bank of America assumed all of the assets and liabilities of Merrill Lynch.

Example 29: Consolidation example: The DaimlerChrysler deal: In 1998 Daimler-Benz, maker of Mercedes-Benz, merged with US auto manufacturer Chrysler. The deal resulted in a new, consolidated entity = DaimlerChrysler.

2. Procedural Requirements

For both corporations in an ordinary merger, the merger requires three requirements: o A ____________________________________ by the directors approving and proposing the

mergers to the shareholders; o ________________________ notice to shareholders and approval by the shareholders; and o Required documents (e.g., plan of merger, amended articles of incorporation) must be filed

with the state.

C. Other Merger-Like Transactions

1. Asset Sales/Acquisitions

o If a corporation sells “all or substantially all” of its assets, the selling corporation must follow the same procedures as with a _____________________ (directorial proposal, written notice to shareholders, and shareholder approval).

o The ________________________ corporation is typically not required to follow these procedures.

Example 30: Suppose Our Corp would like to acquire Their Corp. If Our Corp merges with Their Corp, what procedural requirements apply?

Answer: Generally, approval by Our Corp and Their Corp shareholders is required.

What requirements apply if Our Corp buys the assets of Their Corp instead?

Answer: If it’s all or substantially all of the assets of Their Corp, only approval by ________________________ shareholders is required.


Is Our Corp responsible for the liabilities of Their Corp?

Answer: Generally not, unless Our Corp agrees it is a ____________________________________ of Their Corp.

o Generally, a corporation acquiring assets of another corporation is not liable for all the debts or liabilities of the prior corporation unless it agrees it is a continuation of its predecessor corporation.

Usually, however, sellers and buyers will agree by contract that buyers will assume certain liabilities.

2. Share Exchanges

o One corporation also can buy all of the ________________________ of another corporation pursuant to a share exchange plan.

________________________ are exchanged instead of money.

o The procedures for a merger must be followed for a share exchange.

D. Dissenter Rights

1. Generally

o Shareholders who have the right to ____________ on a merger, asset sale, share exchange, or amendment of the articles of incorporation are entitled to dissenters’ rights.

o Dissenters’ rights give the shareholder the right to have her shares ____________________________________ by the corporation at a ____________ value determined by the court.

2. Procedural Requirements

o To invoke dissenters’ rights, a shareholder must:

Be the ________________________________________________ of the shares on the date of the meeting the proposal will be presented;

Either ________________________ or vote no; and Within 10 days, make a ________________________ demand for fair market value

after the action has been approved (writing must include (i) address of the shareholder, (ii) number and type of shares, and (iii) what the shareholder believes to be the fair market value).

o The corporation must then pay the shareholder what they estimate to be ____________________________________ value.

The fair cash value of a share is the amount that a ________________________ seller who is under no compulsion to sell would be willing to accept and that a willing buyer who is under no compulsion to purchase would be willing to pay.


• Cannot exceed the amount specified in the demand of the particular shareholder.

If the shares are listed on a national securities exchange, the fair cash value is its ____________________________________ on the relevant date.

o If within ____________ months after the demand is made, the shareholder disagrees with the fair value, the shareholder must file a lawsuit to have the value determined by a ________________________.

E. Dissolution - Three Types

1. Voluntary Dissolution

o Voluntary dissolution of the corporation is another fundamental change and requires a resolution by the directors and a shareholder ____________ for approval.

o A dissolved corporation may continue to exist as a corporation for the limited purpose of winding up its affairs and ____________________________________ its business.

o The directors of a corporation are responsible for distribution of the corporate assets during the winding-up process, and may be liable for improper distributions.

2. Involuntary Dissolution

o Involuntary dissolution occurs at the request of a ________________________, a shareholder, a director, or governmental enforcement authorities (e.g., a prosecuting attorney for a county).

o A creditor must show that the corporation is not paying its ________________________. o A shareholder may bring an action in common pleas court to have the corporation dissolved

when:

The corporation’s articles have been ________________________ or its period of existence has expired;

The corporation is ________________________; or The ____________________________________ of the corporation have wholly failed,

have been abandoned, or are impractical to be accomplished.

o ____________________________________ authorities may seek involuntary dissolution when it is found that the corporation was organized or systematically used to further criminal purposes, or as a subterfuge to engage in criminal activity.

3. Dissolution by the Court

o A court may dissolve the corporation if the corporation:

Has violated a statute concerning the ________________________ of the corporation; Has failed to use its privileges of incorporation; Has ____________________________________ its corporate rights; Has ____________________________________ its corporate rights; or


Its articles of incorporation were improperly ________________________ and filed with the state.

o The court will take measures to protect the corporation and its shareholders during any judicial dissolution process.

CHAPTER 8: CLOSE CORPORATIONS AND SPECIAL CORPORATE ENTITIES

Exam Tip 5: Limited liability companies have recently overtaken corporations as the preferred business entity for new businesses.

A. Close Corporations

• Definition: A corporation that has a relatively small number of ____________________________________ and whose shareholders also serve as the directors and officers of the corporation.

o Also known as “closely held corporations.”

• Stock of such a corporation is not ________________________ traded, and many states allow shareholders to do away with many of the corporate formalities required of larger corporations.

• Shareholders in close corporations owe a ________________________ duty to deal with each other in ________________________.

B. Professional Corporation

• Definition: A corporation that renders a particular ____________________________________ service and whose shareholders are all members of the applicable profession (such as law).

• Shareholders are not shielded from liability for their own malpractice or malpractice by those they supervise, but they are protected from ________________________ for the malpractice of other ____________________________________ or for other obligations of the corporation.

C. “S” and “C” Corporations

• “S” corporations forms for state corporate law purposes and gets special tax treatment, and “C” corporations are basis corporations, and are larger corporate entities.

• Basis corporations (“C” corporations) are double ________________________.

o Profits are taxed when they are brought in, and shareholders are also taxed on the distributions they receive.

• “S” Corporations, have “____________________________________” taxation.

o The income and expenses of the corporation are passed through to the shareholders, as with a partnership.

• To qualify as an “S” corporation, the corporation must have a limited number of ____________________________________ and only ________________________ of stock.


D. Limited Liability Company (LLC)

1. Comparison to “S” Corporations

o Like an S Corp, an LLC combines the (federal) tax advantages of a partnership with the limited liability of a corporation.

o LLCs are a very flexible form of entity; it is not subject to the same restrictions on ____________ or number of classes of stock as an S Corp.

2. Key Characteristics

o An LLC files Articles of ____________________________________ with the state, and it generally adopts an ____________________________________ agreement to govern other details of its governance.

These play the role that articles of incorporation and bylaws play with a corporation.

o A limited liability company’s name must include the words, “limited liability company,” or “LLC,” “L.L.C.,” “limited,” “ltd.,” or “ltd”, and be distinguishable from other registered entities and trade names.

o The operating agreement generally takes precedence over contrary ____________________________________ provisions, but there are limitations. The operating agreement cannot:

Vary the rights and duties associated with the articles of organization; Unreasonably restrict the right of ________________________ to the company’s books

and records; Eliminate the duty of ________________________; Unreasonably reduce the duty of ____________owed by members; Eliminate the obligation of ________________________ and fair dealing; Eliminate the statutory duties of a ________________________; Vary the statutory requirements of winding up the company’s business; or Restrict the rights of ____________________________________.

• However, the LLC may modify, waive, or eliminate the duties of loyalty and care for one or more members, managers, or officers, by written agreement.

3. Membership

o The owners are known as members, rather than shareholders. o An LLC is not restricted as to the number of members it may have. However, a person

cannot become a member of an LLC without the consent of all other members of an LLC. o An LLC is presumed to be managed by ________________________ of its members (i.e.,

member managed) unless otherwise specified (i.e., manager managed). o A member of an LLC is generally ____________________________________ as a member

for an LLC’s obligations.


If a member renders professional services in an LLC, the member, as well as the LLC, may be liable for ____________ committed while rendering such services.

However, a manager or a managing member of an LLC is not ______________________ liable for obligations incurred on behalf of the LLC.

o In the absence of an operating agreement provision stating otherwise, profits and losses are allocated and distributions are made according to each member’s percentage of ________________________________________________ to the LLC.

o If a member sells a membership interest, the buyer has a right to share in the LLC’s profits and losses, but she is not entitled to participate in __________________________________ unless all of the other members ________________________.

o Withdrawal of a member from an LLC does not automatically trigger ____________________________________ of the LLC.

The LLC may elect to ____________________________________ the fair value of that person’s interests.

The continuing members of the LLC following the withdrawal of a member will be deemed to have entered into an operating agreement in effect immediately prior to the withdrawal, and the members bound by the operating agreement shall be only those members who have not withdrawn.

4. Mergers and LLC’s

o An LLC may merge with another LLC or another business entity (e.g., partnership, corporation).

o An LLC may dissolve upon the occurrence of various events, such as mutual ________________________ of the members or the lack of any members.

5. Comparison to Corporations

o LLC’s are a separate form of entity than ordinary corporations, but their treatment on most issues (such as managers’ fiduciary duties) is likely to be quite similar.

Exam Tip 6: If a question involves an LLC, briefly note the distinctions in terminology (for example, articles of organization vs. articles of incorporation). Then state that the analysis is likely to be similar to general corporate law analysis, and apply corporate law principles.

[END OF HANDOUT]

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