California Business Associations

What is a Corporation?

➲ A Corporation is a legal entity that exists separate from its owners, thus shielding the owners and managers from personal liability for the actions of the Corporation.

Note: A person is liable for their own torts even if they were acting through a Corporation.

Corporation Classifications

⚖️ de jure Corporation

➲ A de jure Corporation [of right, of law - you did it right!] is a business which has complied with all the mandatory requirements of its state incorporation statute and thus is legally permitted to function as a Corporation.

A Corporation with de jure status is allowed to issue stocks in the market, hold board of directors meetings, and conduct day to day business.

Requirements of California's Incorporation Statute

➲ At least one incorporator (who can be a person or another Corporation) must sign and file an articles of incorporation with the Secretary of State [if accepted = conclusive proof of valid formation of a de jure Corporation] that includes the following information:

✅ Initial Registered Agent's name [Legal Representative] for the Corporation - can receive service of process for the Corporation;

✅ Street address for the Corporation's initial Registered Office;

✅ Corporation's name [must include the magic words: Inc., Corp., Incorp., Ltd., or Co.];

✅ Authorised number of shares (maximum allowed), number of shares per class, + information on voting rights and preferences of each class;

✅ Name and address of each incorporator + initial director.

If there is no statement of the Corporation's duration, we presume perpetual existence.

Statement of Purpose is normally general such as "engage in all lawful activity, after first obtaining necessary state agency approval".

In some states, general purpose is presumed and the articles need not say anything about the Corporation's purpose.

The articles of incorporation are a:

1️⃣ Contract between the Corporation and its Shareholders; and also a

2️⃣ Contract between the Corporation and the State.

⚖️ Separate Legal Entity

A Corporation is a separate legal entity.

It can sue and be sued, hold property, be a partner in a partnership, make charitable contributions, etc.

It is taxed on its profits.

In addition, Shareholders are taxed on distributions.

So there is "double taxation" for a standard "C" Corporation.

⚖️ "S" Corporation to avoid double taxation

To avoid double taxation, you can form an "S" Corporation which does not pay tax at the corporate level.

✅ Closely Held Corporation of no more than 100 [human + U.S. citizen or resident] Shareholders;

✅ Not publicly traded;

✅ One class of stock.

⚖️ Foreign Corporation

Any Corporation formed or incorporated outside California is a Foreign Corporation.

Foreign Corporations transacting business in the state must qualify and pay prescribed fees.

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

So it doesn't include:

❌ Occasional or sporadic activity in California; or

❌ Simply owning property in California.

The Foreign Corporation qualifies by getting a certificate of authority from the Secretary of State.

It gives information from its articles and proves good standing in its home state.

It must have a registered agent in California and pay the prescribed fees.

What if a Foreign Corporation transacts business in California without first qualifying?

1️⃣ Civil fine; and

2️⃣ Cannot sue in California (but it can be sued and defend).

Once the Foreign Corporation qualifies and pays back fees and fines, it can sue in California.

However, the Foreign Corporation needs to be fully aware of delays in the process v. statute of limitations deadlines + the equitable defence of laches.

⚖️ Professional Corporation

Licensed professionals, including lawyers, medical professionals, and CPA's may incorporate as a "Professional Corporation" or "Professional Association".

The name must contain one of these phrases or the abbreviations "P.C." or "P.A."

The Articles must state that the purpose is to practice in a particular profession.

Directors, Officers, and Shareholders usually must be licensed professionals.

Non-professionals can be employed, but not to render professional services.

Professionals are still personally liable for their own malpractice.

A person is always personally liable for their own torts.

Shareholders are generally not liable for corporate obligations or for other professionals' malpractice.

Generally, the rules governing regular Corporations apply to the P.C.

⚖️ de facto Corporation

➲ A de facto Corporation exists where there is actual use of corporate power and a good faith, but unsuccessful attempt to incorporate under a valid incorporation statute.

If a Corporation has been defectively formed in good faith (colorable attempt to comply with the statute) such that a de facto Corporation arises, then:

1️⃣ Limited liability: The law will treat the defectively formed Corporation as an actual Corporation and the Shareholders will not be personally liable for corporate obligations.

2️⃣ Determination: The state may deny corporate entity status in a quo warranto proceeding, but third parties may not attack the corporate status.

A quo warranto proceeding is a special form of legal action used to resolve a dispute over whether a specific person has the legal right to hold the office that he or she occupies.

⚖️ Corporation by Estoppel

1️⃣ A person who deals with a business entity believing it is a Corporation; or

2️⃣ One who incorrectly holds the business out as a Corporation.

May be estopped from denying Corporation status.

This applies on a case-by-case basis and only in contract (conscious decision, reliance on corporate status), not to tort cases.

In tort cases you don't decide who you are dealing with.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Corporate Powers

It is assumed that all Corporations are formed for any lawful business purpose unless the articles define a limited, specific purpose.

❌ Ultra Vires acts: If a Corporation has a limited stated purpose and it acts outside its stated business purpose, it is acting "ultra vires".

At common law, an "ultra vires" contract could be voided.

Modernly, "ultra vires" acts are generally enforceable as to 3rd parties.

Ultra vires acts may be raised when:

1️⃣ The "ultra vires" act causes the State to seek dissolution;

2️⃣ The Corporation sues an Officer/s or responsible manager/s or employee/s (presumably who has purported to act on behalf of the Corporation in committing the ultra vires act) for losses caused by the ultra vires act; or

3️⃣ A Shareholder sues to enjoin (or urgently stop - usually via an injunction) the proposed ultra vires act.

⚖️ Corporate Powers (Acquire Debt)

Corporations may borrow funds from outside sources to pursue the corporate purpose.

Lenders do not acquire an ownership interest in the Corporation.

Debts may be secured (a bond) or unsecured (a debenture).

⚖️ Corporate Powers (Issue Stock)

A Stock Subscription Agreement is a contract where a subscriber makes a written promise agreeing to buy a specified number of shares of stock.

A post-incorporation subscription creates a contract between the subscriber and the Corporation.

The contract is formed when the Board accepts the offer, therefore:

✅ A post-incorporation subscription is revocable until acceptance by the Board.

A pre-incorporation subscription is irrevocable for 6 months unless:

✅ Otherwise stated in the agreement; or

✅ All subscribers agree to revocation.

Shares of Stock are equity securities that give the shareholder an ownership interest in the Corporation.

Quantity of shares available: The articles of incorporation authorise the number of shares available to be sold.

Shares that are sold are issued and outstanding.

Shares that have yet to be sold are authorised but unissued.

Types of Shares: The Articles of Incorporation can provide that different classes of stock shares are available (common or preferred).

Preferred shares must state:

✅ The number of shares in each class;

✅ A distinguishing name/classification for each class; and

✅ The rights, preferences, limitations, etc., of each class.

Consideration is required in exchange for stock shares and can include any tangible or intangible property or benefit to the Corporation, such as cash, property, an exchange for past services rendered, or cancellation of a debt owed, etc.

The Board determines the value of the property, past services, etc.

The Board's valuation is conclusive, so long as it was made in good faith.

Jurisdictions are split as to whether to include the exchange for future services or promissory notes, that is, unsecured debt (e.g., the Revised Model Business Corporation Act (RMBCA) does allow these; *CA does not).

💡 Purporting to use invalid forms of consideration results in “unpaid stock” (meaning it is treated as water).

The Corporation will seek recovery for the value of the unpaid stock or water from:

✅ The Directors if they knowingly authorised the issuance of stock for invalid consideration; and potentially

✅ The purchaser of the stock (if they had notice that their consideration was invalid, or have not yet performed the future services, etc).

Traditional par value approach means the price is the stated minimum issuance price. Stock may not be sold by the Corporation for less than par value.

💡 Whenever a par price has been set, watch for watered stock.

The Corporation will seek recovery for the value of the unpaid stock or "water" from:

✅ The Directors, if they knowingly authorised the issue of stock for less than the par value.

✅ The purchaser of the stock (there is no defence; the purchaser is charged with notice of the par value.)

❌ If the purchaser transfers the shares to a third-party (TP). TP is not liable if they did not know about the water.

Board's good faith: No par approach means there is no minimum issuance price for the stock; generally the board of directors' good faith determination of the price is conclusive.

Treasury Stock: is the stock that was previously issued and had been reacquired by the Corporation. It can be resold for less than par value and is treated like no par stock.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Potential Liability of Directors + Officers

1️⃣ Losses caused by Ultra Vires Acts;

2️⃣ Improper distributions (see discussion below);

3️⃣ Breach of Director/Officer Duties;

 4️⃣ Improper loans - OK only if it is reasonably expected to benefit the Corporation.

💡 Sarbanes-Oxley Act (Federal Law) generally forbids loans to executives in large, publicly traded ("registered") Corporations.

It requires the Board of such a large Corporation to establish an audit committee and to oversee work of registered public accounting firm.

Chief executive and financial officers must certify accuracy and completeness of financial reports.

⚖️ Which Directors are liable?

⚖️ Defences

✅ Dissenting members: A Director is presumed to concur with Board action unless their dissent or abstention is noted in writing in corporate records.

In writing means:

1️⃣ Recorded in the minutes; or

2️⃣ Delivered in writing to the presiding officer at the meeting; or

3️⃣ Written dissent, delivered to the Corporation immediately after the meeting.

❌ A Director cannot dissent if they voted for the resolution at the meeting.

✅ An absent Director is not liable for Board action done at the meeting they missed.

Defe

✅ Reliance on others: It is not unreasonable for a Director to rely in good faith on information (including financial information) presented by an officer, legal counsel, committees (where the Director was not a member), or professional reasonably believed competent.

💡Point of comparison: This ability to rely on the information from others is in direct contrast to the position of directors in Australia, who must exercise their own independent judgment + cannot rely blindly on the advice/information of officers/experts.

For a more detailed discussion please refer to my blog article: The Business Judgment Rule for Directors [Australia v. U.S.A.]

⚖️ Indemnification

💡The Articles of Incorporation can provide for indemnification of a Director or Officer for liability while acting in their role UNLESS they are:

❌ Held liable to the Corporation;

❌ Held to have received an improper financial benefit; or

❌ Committed intentional wrongful acts or crimes.

Mandatory Indemnification

The Corporation must indemnify the Director or Officer if they have prevailed in defending the proceeding against them.

Permissive Indemnification

The Corporation may indemnify the Director or Officer if the case is settled, or in any other situation not covered above.

Eligibility standard: Must show they acted in Good Faith and with a reasonable belief that their actions were in the Corporation's best interest.

Same standard as Duty of Loyalty.

Who determines eligibility?

Disinterested Directors or Shareholders or Independent Legal Counsel.

The Court may order reimbursement in its own discretion

Where a Director or Officer is sued, a Court may decide to order reimbursement if it is justified in view of all of the circumstances.

If they are held liable to the Corporation, this reimbursement is limited to costs and attorney's fees (cannot include judgment).

Important decision to make when drafting the Articles:

⚖️ Whether or not to add an exculpation clause?

Articles can include a clause which eliminates Director liability to the Corporation for damages, but not for intentional misconduct, usurping corporate opportunities, unlawful distributions, or improper personal benefit.

Can exculpatory provisions apply to Officers as well?

Split authority: Some states Yes, some No.

⚖️ Federal Securities Laws

Debt Securities: The investor lends capital to the Corporation, to be repaid (usually with interest) as specified in the agreement.

The debt holder is a creditor.

➲ Secured by corporate assets (bond)

➲ Unsecured (debenture).

Equity Securities: The investor buys stock from the Corporation, which generates capital for the business. Investor is an owner.

⚖️ Insider Trading Rule 10b-5

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

Possible Plaintiffs

✅ Securities and Exchange Commission (SEC)

✅ Private action for damages by buyer or seller of securities. If didn't buy or sell, then no cause of action.

Possible Defendants - any person (including entities)

❌ Company that issues misleading press release.

❌ Buyer or Seller of securities who misrepresents material information.

❌ Buyer or Seller of securities who trades on material inside information

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

❌ Tipper or Tippee.

Financial Benefit - clear

Still liable if you only get a personal benefit, but personal benefit is broadly defined.

Enhancing reputation is enough.

💡 Note: When there is no tipper, there cannot be a tippee.

Elements:

1️⃣ At some point the deal must use "instrumentalities and channels of interstate commerce".

This means the facilities enabling the movement of goods and people in interstate commerce or used for interstate communications.

2️⃣One of the following transaction types

❌ Misrepresentation of material information

❌ Insider trading: Trading securities on the basis of material inside information. This is only a problem for someone high enough in the business hierarchy that they have a duty to abstain or ensure disclosure so that everybody's on the same footing.

Who has this duty?

Someone with a relationship of trust and confidence with Shareholders.

Generally this would include:

Directors;

Officers:

Employees of the insurer with access to confidential information.

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

❌ Tipping: Here, an insider passes along material inside information for a wrongful purpose.

3️⃣ Materiality

The misrepresentation or omission must concern a "material" fact. One a reasonable investor would consider important in making an investment decision.

4️⃣ Scienter / Intent

D must have an intent to deceive, manipulate, or defraud.  Recklessness may suffice.

Negligently holding a confidential conversation in a public space is not enough for 10b-5 liability.

5️⃣ Reliance

Said to be a separate element, as in fraud cases, but is presumed in public misrepresentation (e.g., a misleading press release) and nondisclosure cases.

6️⃣ Damages

Generally determined by an out-of-pocket measure.

⚖️ Short-Swing Profits Rule 16(b) - Strict Liability

Federal law provides for the recovery by the Corporation (or its shareholders via a derivative suit) of "profits" gained by certain insiders from buying and selling the company's stock.

If, within 6 months before or after any sale, there was a purchase at a lower price, there is a profit.

The sequence of the buy and sell does not matter.

⚖️ Applied to public companies or "Reporting" Corporation

✅ Listed on a national exchange;

at least 2,000 Shareholders; or

500 Non-Accredited Shareholders; and

✅ $10 million in assets.

Accredited Investor is a defined term meaning, in general, an investor who can handle risk, such as an institutional investor or wealthy individual.

Types of Defendants:

👉 Director (either when they bought or sold); or

👉 Officer (either when they bought or sold); or

👉 Shareholder who owns more than 10% (both when they bought and sold).

Type of transaction:

Short-swing trading: Buying + Selling stock within a single 6 month period.

No fraud or inside information is needed.

⚖️ Sarbanes-Oxley Act sets Standards for Publicly Traded Companies

Board oversees public accounting firms that perform audits and create rules pertaining to corporate financial reporting

Enhanced Reporting Requirements, including:

✅ Audit Board;

✅ Senior executives;

✅ If a filing is inaccurate.

Criminal Penalties:

❌ Destroying or altering corporate documents and/or audit records is punishable by ➲ A $5million fine + up to 20 years in prison;

❌ Securities Fraud ➲ Up to 25 years in prison;

Statute of Limitations is the later of 2 years after discovery or 5 years after the action accrued.

Whistleblowers are afforded protection.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Rights of Directors + Officers

Fair Compensation: A Director or Officer is entitled to fair compensation, the rate of which the Board of directors determines.

Note: It is not a conflict of interest for the Board to set reasonable director compensation in good faith unless the articles or by-laws state otherwise. If excessive itis a waste of corporate assets and a breach of the Duty of Loyalty.

Indemnification:

✅ Mandatory indemnification for expenses incurred:

1️⃣ On behalf of the Corporation; and for

2️⃣ Expenses incurred if they prevail in a proceeding brought against them by the Corporation.

❌ Discretionary indemnification where the director or officer is unsuccessful in proceedings brought against them by the Corporation if they:

1️⃣ Acted in good faith; and

2️⃣ They believed their actions were in the best interest of the Corporation;

❌ Unless they are liable due to an improper financial benefit.

Inspection: A Director or Officer has a right to a reasonable inspection of corporate records or facilities.

⚖️ Duties of Directors + Officers

1️⃣ Duty of Care [Burden on the Corporation Plaintiff]

State the Duty of Care standard: A Director or Officer owes the Corporation a duty of care.

They must act in good faith and do what a prudent person would do with regard to their own business.

Nonfeasance: The Director does nothing.

Apply the standard: A prudent person would attend some meetings and so some work. If the Director never did anything, they have breached the duty of care.

‍Liable only if the breach caused a loss to the Corporation.

Misfeasance: The Board does something that hurts the Corporation - so causation in these cases is clear.

Apply the standard: Here, the Directors' action caused a loss to the Corporation and was arguably imprudent given that it turned out badly BUT a Director is not liable if they meet the Business Judgment Rule (BJR).

⚖️ The Business Judgment Rule

A Court will not second guess a business decision if it was:

1️⃣ Informed;

2️⃣ Made in Good Faith;

3️⃣ Without Conflicts of Interest; and

4️⃣ Had a Rational Basis.

So, are the Directors' liable here for breach of the duty of care?

It depends on the facts.

✅ Was the Board reasonably informed?

✅ Did it do appropriate homework before making the decision (analyze information, deliberate)?

✅ Did it act in good faith, free of self-interest, and with the belief that the decision was in the best interest of the Corporation?

If so, the Directors' are not liable, despite the poor substantive outcome of the decision, because the BJR recognizes that a Director is not a guarantor of success.

Reliance on others: It is not unreasonable for a Director to rely on information from officers, legal counsel, committees, etc. the Director reasonably believes to be reliable and competent.

💡Point of comparison: This ability to rely on the information from others is in direct contrast to the position of Directors in Australia, who must exercise their own independent judgment + cannot rely blindly on the advice/information of officers/experts.

For a more detailed discussion please refer to my blog article: The Business Judgment Rule for Directors [Australia v. U.S.A.]

2️⃣ Duty of Loyalty [Burden on the Defendant Director]

❌ The BJR does not apply, it's about conflict, not business judgment.

State the Duty of Loyalty standard: A Director or Officer owes the Corporation a duty of loyalty.

They must act in good faith and with a reasonable belief that what they do is in the corporation's best interest.

❌ Conflict of Interest (self-dealing) = Interested Director Transaction

A Director or Officer has a conflict when they (or a Corporation they own or have a relationship with, or their family member):

1️⃣ Enter into a contract with the Corporation; or

2️⃣ Have a beneficial financial interest in a contract.

Self-dealing contracts are presumed unfair + voidable.

The Interested Director Transaction will be set aside (or the Director will be liable in damages) UNLESS the Director shows the conflict was cured.

The Conflict can be shown to be cured if:

✅ Authorised by disinterested directors after material disclosure; or

✅ Approved by a majority of disinterested shareholders after material disclosure; and

✅ The transaction was fair to the Corporation when entered into.

Even if the deal is approved by an appropriate group:

Some Courts always require a showing of fairness even if disinterested directors/shareholders approve it.

❌ Usurping a Corporate Opportunity (Expectancy)

A Director or Officer may not personally act on a business opportunity without first offering it to the Corporation where the Corporation would expect to be presented the opportunity.

What opportunities would the Corporation expect to be presented with?

⚖️ Some say it's something in the Corporations line of business.

There are other tests to through in:

⚖️ Something the Corporation has an contractual or property right interest or expectancy (tentative claim); or

⚖️ Something the Director or officer found on Co. time or with Co. resources.

Q: Is the Corporation's financial inability to pay for the opportunity a defence?

A: Probably not.

The director or officer may take the opportunity only after:

✅ Good faith rejection of the opportunity by the Corporation if there was full disclosure of all material facts to a disinterested board majority.

Remedy: If the Director or Officer usurps a corporate opportunity, then the Corporation may compel that Director or Officer to:

1️⃣ Turn over the opportunity at the Director's cost; or

2️⃣ Disgorge profits (constructive trust equitable restitution theory).

❌ Competing Ventures

A Director or Officer may not unfairly compete with the Corporation.

Remedy: If the Director or Officer unfairly competes, then the Corporation may compel that Director or Officer to:

1️⃣ Turn over the relevant competing opportunity/opportunities; or

2️⃣ Disgorge profits (constructive trust equitable restitution theory).

3️⃣ Duty to Disclose

Directors and Officers have a duty to disclose all material information relevant to the Corporation to Board members.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Corporation Management, Directors + Officers

✅ Director required: All Corporations must have at least 1 director (no maximum + numbers may vary);

✅ Articles of incorporation are publicly filed with the state to establish the Corporation, and any provisions contained in the articles will govern the Corporation;

✅ By-laws: Management of the Corporation is conducted in accordance with the articles of incorporation and any by-laws (private internal to the Corporation) adopted by the board, which typically contain management provisions;

✅ Election of the Board of Directors: The initial board is elected at the first annual meeting and each year thereafter unless terms are staggered;

✅ Officers + Committees are appointed by the Board to implement Board decisions + carry out operations.

A Committee of 1 or more Directors can make recommendations to the full board for its action, but cannot:

❌ Fill board vacancies; or

❌ Declare dividends.

✅ Officer authority: Officers have authority to act on behalf of the Corporation based on agency law principles.

An Officer's authority to bind the Corporation may be express, implied or apparent.

Officers owe the same Duties of Care and Loyalty as Directors.

The president or chief executive of a Corporation has implied actual authority (and apparent authority) to bind the Corporation to contracts in the ordinary course of business.

Traditionally, and in California a Corporation must have a president, secretary and treasurer. Can have others.

Today, and in California, one person can hold multiple offices simultaneously.

The Revised Model Business Corporation Act (RMBCA) doesn't require that a Corporation have any officers.

Removal of a Director: A Director may be removed with or without cause by a majority shareholder vote, unless the articles state removal only with cause permitted.

Who selects the Director's replacement?

Generally the Board or the Shareholders.

If the Shareholders caused the removal of the Director, generally they must select the replacement.

Removal of an Officer: The Board may remove an officer at anytime with or without cause (subject to the terms of their employment agreement).

It can therefore be assumed that removal of an officer without cause will in most cases incur liability for contractual breach by the Corporation.

A principal can always terminate an agent.

Resignation: A Director or Officer may resign at anytime with notice.

💡 Shareholders hire and fire Directors, and the Board hires and fires Officers.

⚖️ Actions of the Board of Directors

Meetings: The Board of Directors must hold meetings, which may be regular meetings (no notice required) in accordance with the by-laws or unscheduled special meetings requiring at least 2 days' notice of time + place [no need to specify the purpose].

Failure to give required notice: Voids the meeting, unless the Directors not sufficiently notified waive the notice defect.

✅ Directors can do this in writing at anytime, or by attending the meeting without objecting.

Quorum requirement: A quorum, which is the majority of the Board of Directors, must be present at the time a vote is taken for board action to be valid, unless by-laws or articles allow otherwise.

Note: No fewer than 1/3 of Board members can be used to establish a quorum.

Presence: Presence can be by any means of communication (zoom conference call is an example) so long as all members can hear each other and the means is not prohibited by the articles or by-laws.

❌ Members with conflicts don't count toward the quorum.

❌ Proxies or Voting Agreements not allowed for Directors.

Broken Quorum: Unlike the situation for shareholders, a Director may break quorum by withdrawing from a meeting before the vote is taken.

Dissenting members: A Director is presumed to concur with Board action unless their dissent or abstention is noted in writing in corporate records.

In writing means:

1️⃣ Recorded in the minutes; or

2️⃣ Delivered in writing to the presiding officer at the meeting; or

3️⃣ Written dissent, delivered to the Corporation immediately after the meeting.

❌ A Director cannot dissent if they voted for the resolution at the meeting.

Actions without meetings: An action can be taken without a meeting:

✅ If all Directors sign a written consent describing the action taken and include that in the minutes or file it with corporate records; otherwise

❌ The action is void, unless ✅ Validly Ratified by the Board at a later time.

Delegation: The Board may delegate authority to a committee, or an officer.

⚖️ Fundamental Corporate Changes

Fundamental changes to the corporate business cannot be decided by the Board alone, they must be approved by a Majority Shareholder Vote.

Majority Shareholder Vote: At a meeting where a quorum was present to start the meeting, votes cast in favour must exceed votes cast against.

Typical procedure to make a fundamental change:

✅ Board adopts a resolution of fundamental change;

✅ Written Notice is given to Shareholders (10-60 days before next shareholder meeting where vote will occur);

✅ Shareholders approve the change by Majority Vote;

✅ The change is updated in the articles, which are filed with the state [Not required if only assets have been sold].

Note: Some jurisdictions require the vote to be by a majority from the votes entitled to be cast, which is a higher standard than the typical quorum rule.

⚖️ Types of Fundamental Corporate Changes

1️⃣ Merger (or Consolidation where A Corp., and B Corp., form C Corp.);

Short-form merger [No shareholder meeting/approval required if a 90% or-more owned subsidiary is merged into a Parent Corporation].

💡 Note: Surviving Corporation succeeds to all rights and liabilities.

2️⃣ Share exchange;

3️⃣ Sale of Substantially All [varies from state to state: rule of thumb at least 75%] of the Assets Not in the Ordinary Course of Business;

💡 Note: Only a Fundamental Corporate Change for the Selling Corp.

4️⃣ Conversion;

5️⃣ Amendment of Articles or by-laws after shares have been issued requires:

✅ Approval of the directors and shareholders;

✅ The amendment must be filed with the state

No Shareholder approval needed to delete names of directors or agents, change company name or corporate abbreviations (eg., Inc. to Corp.), or to change the number of shares in share split if only 1 class (if more than 1 class, then each class can vote as a group).

6️⃣ Dissolution + Winding Up

Voluntary Dissolution

Judicial Dissolution [By Court Order]

1️⃣ A Shareholder can petition for involuntary dissolution because of:

❌ Director abuse, waste of assets, misconduct;

❌ Director deadlock that harms the Corporation; or

❌ Shareholders have failed at two consecutive annual meetings to fill a vacant Board position.

A Court might order buy-out of the objecting Shareholder as an alternative to ordering involuntary dissolution especially in a closely-held Corporation.

2️⃣ A Creditor may petition because the Corporation is insolvent and they have a unsatisfied judgment or the Corporation admits the debt in writing.

Next Step: Wind-up or Liquidate the Corporation.

✅ Gather all assets;

✅ Convert to cash;

✅ Pay Creditors;

✅ Distribute remainder to Shareholders, pro-rata by share unless there is a liquidation preference.

A liquidation preference must be specified in the Articles.

Involuntary Administrative Dissolution

When a Corporation fails to timely file an annual report, fails to maintain a registered agent, the Secretary of State may administratively dissolve the Corporation.

⚖️ Dissenter Appraisal Rights

A dissenting Shareholder to [any of the following: Merger or Consolidation, Transfer of substantially all assets not in the ordinary course of business, or transfer of shares in a share exchange, or an Amendment of the Articles that effectuates a reverse stock-split] may exercise their right to force the Corporation to buy them out at fair value.

❌ Right not available if the stock is listed on a national exchange; or has

❌ 2,000 or more Shareholders.

✅ So, in effect, the right of appraisal exists in closely-held Corporations.

💡 The right may exist even without dissenting at an actual Shareholder Meeting - as in the case of a short-form merger.

To perfect the right:

1️⃣ Before Shareholder vote, file written notice of objection + intent to demand payment;

2️⃣ Abstain or vote against the proposed change; and

3️⃣ After the vote, within time set by Corporation, makewritten demand to be bought out and deposit stock with the Corporation.

If the Shareholder and the Corporation cannot agree on a fair value, the Court may appoint an appraiser.

This is the Shareholders' only remedy for these fundamental changes (absent fraud).

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Rights of Shareholders

⚖️ Meetings

Meetings are typically where Shareholders convene + vote on corporate management issues.

General Meetings or annual meetings occur once a year and are where most Shareholder voting occurs (10-60 days notice required).

If none held within 15 months, a Shareholder can petition the Court to order one.

Special Meetings can be called by the Board, or the President, or the holders of at least 10% of the voting shares, or anyone else authorised by the by-laws.

The special meeting is held upon reasonable notice of the time, place and purpose to be discussed (10-60 days' notice required + purpose).

⚖️ Voting

Right to Vote: The right to vote attaches to the type of stock held by the Shareholder.

A Corporation can have 2 types of stock: common + preferred.

If the articles do not specify voting rights, both classes of stock may vote.

Usually each outstanding share is entitled to 1 vote.

‍Voting: Generally, Shareholders only have indirect corporate power through the right to vote to elect or remove members of the board and approve fundamental changes in the corporate structure, such as mergers, dissolutions, etc.

Who Votes?: General rule is the "record Shareholder" as of the"record date" has the right to vote.

Exceptions: Corporation re-acquires shares (which become treasury stock) before the record date ➲ The Corporation does not vote on this stock.

➲ Shareholder dies after the record date. Shareholder's executor can vote the stock.

Voting by proxy: A Shareholder may vote in person or by proxy (valid for 11 months unless the proxy says otherwise).

A proxy is a signed writing (can be electronic) authorizing another to cast a vote on behalf of the Shareholder.

A revocable proxy is an agency relationship between the shareholder and the proxy.

An irrevocable proxy can only occur when the proxy is coupled with some interest of the proxyholder (other than voting).

✅ The irrevocable proxy must be so labeled.

✅ The proxyholder's interest can relate to some other interest in the shares (e.g., a creditor or prospective purchaser under an option contract or actual purchaser after the record date) or an interest in the Corporation (e.g., performance of services or granting credit in exchange for proxy rights).

💡 Note: If there is no coupled interest, then a proxy clearly labelled as irrevocable, is actually still revocable.

Quorum: For an action to pass there must be a quorum, which is a majority of outstanding shares represented (in person or by proxy) at the meeting. Quorum is based on the number of shares, not the number of shareholders.

Majority Vote: If a quorum is present, a majority of votes cast validates the proposed Shareholder action.

‍Except votes regarding a fundamental change require a majority vote of all outstanding shares to validate the proposed action (A higher standard),.

Vote calculation: 2 methods are employed:

1️⃣ Straight counting: Each Shareholder casts one vote per share held.

Therefore a Shareholder with more than 50% of the shares controls the vote.

2️⃣ Cumulative voting for directors: Allows a Shareholder to multiply the numbers of shares held by the number of Directors to be elected and then cast all votes for one or more Directors.

💡 Cumulative voting is the law for all Corporations in California that are not publicly traded (there is no opt-out provision).

The rationale behind cumulative voting is that the process translates into more proportional representation of the Shareholders on the Board of Directors, giving minority Shareholders the opportunity to exert influence on management through the election of Directors who support their interests and priorities.

Unanimous written consent: Shareholders may also take action with unanimous written consent from all Shareholders.

⚖️ Inspection of Company Records

Inspection: A Shareholder has a right to inspect the corporate books (articles, resolutions, shareholder meeting minutes, etc.) upon:

✅ A showing of a proper purpose; with

✅ 5 days' written notice.

As to accounting or shareholder records or board minutes, the demand must be:

✅ Made in good faith and describe with reasonable particularity the purpose for the inspection, and the records must be directly connected to the stated purpose.

⚖️ DIvidends

Dividends: Dividends are the discretionary (at the Board's discretion) distribution of cash, property or stock that a Shareholder may receive from a Corporation.

❌ A distribution is not permitted if it would lead to insolvency or is not allowed in the articles.

Types of dividend distributions:

1️⃣ Preferred with dividend preference: Paid first to preferred with dividend preference as to stated amount, then remaining amount is paid to common stock;

2️⃣ Preferred + Participating: Paid first to preferred + participating as indicated in preferred amount, then remaining is paid to common stock which includes the preferred + participating Shareholders.

So P+P are paid preferred, and then also participate in the common stock dividend distribution.

💰💰Double Dip!

3️⃣ Preferred and cumulative: Paid first to preferred and cumulative as indicated for number of years not paid in the past, then remaining paid to common stock.

4️⃣ Cumulative if earned: Dividends cumulative only if the Corporation's total earnings for the year are more than the total amount of preferred dividends that would need to be paid out for the year.

⚖️ Proper + Improper Distributions

Which funds can be used to pay Dividends?

➲ Traditional view

1️⃣ Earned Surplus [Earnings - Losses - Distributions Previously Paid] Ok to be used for Dividends.

2️⃣ Stated Capital [Generated by issuing stock at par. value]. Never to be used for distributions. Policy: Keep in hand to pay creditors.

3️⃣ Capital Surplus [Generated by issuing any stock at a premium to par. value]. Ok to be be used for Dividends, if you inform the Shareholders.

On a no-par issuance, the Board allocates between stated and capital surplus.

➲ Modern view does not look at the funds.

It says a Corporation cannot make a distribution if it is insolvent or if the distribution would render it insolvent.

Insolvent means either:

❌ The Corporation is unable ti pay its debts as they come due; or

❌ Total assets are less than total liabilities (and liabilities include preferential liquidation rights).

⚖️ Improper Distributions ➲ Liability

Directors are jointly + severally liable for improper distributions (except where there is a Directors' Good Faith reliance defence).

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

⚖️ Preemptive Rights: The right to subscribe to new stock issues for cash such that your existing shareholding is not diluted

The right of an existing Shareholder to maintain her percentage of ownership in a Corporation when there is a new issuance of stock for cash (or its equivalent, like a check).

❌ Not applicable: If the new issuance is not for cash.

Modernly, [Opt-in rule] unless the articles of incorporation provide otherwise, a Shareholder does not have preemptive rights.

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

Split Authority: No clear majority.

⚖️ Shareholder Agreements

⚖️ Voting Agreements

Often seen in closely-held Corporations.

Voting "Pooling" Trust: (valid for 10 year maximum).

✅ The time limit has been eliminated in many states due to the Revised Model Business Corporation Act (RMBCA).

Occurs when Shareholders:

1️⃣ Agree in writing to transfer their shares to a trustee who votes and distributes dividends in accordance with the voting trust;

2️⃣ Copy is provided to the Corporation;

3️⃣ Legal title to the shares is transferred to the voting trustee;

4️⃣ Original Shareholders receive trust certificates and retain all Shareholder rights except for voting.

Voting Agreement: A written agreement where the parties agree to vote their shares as agreed.

In some states Voting Agreements are specifically enforceable (if so, there is no need for a Voting "Pooling" Trust; in other states this is not the case and a Voting Trust is required.

Management Agreement: Occurs where the Shareholders agree to manage the Corporation in an agreed-upon way as set forth in the articles or by-laws (valid for ten years).

⚖️ Restrictions on Stock Transfers

Generally upheld if reasonable.

For example: A right of first refusal, but absolute restraints are not reasonable.

A 3rd party will only be bound:

✅ If the restriction is conspicuously noted; or

✅ The 3rd party had knowledge.

⚖️ Shareholder Suits

Direct: A Shareholder may bring a suit for breach of fiduciary duty owed to the shareholder (not the Corporation itself).

Derivative: A Shareholder may bring a derivative suit on behalf of the Corporation for harm done to the Corporation.

The Corporation receives the recovery, if any, and the Shareholder is entitled to reimbursement for the expenses of litigation.

The Shareholder bringing the suit must:

1️⃣ Own stock at the time the claim arose and throughout the suit;

If not owned directly, Ok to have gotten the stock by "operation of law", that is, inheritance/divorce.

2️⃣ Adequate representation of the Corporation's interest;

3️⃣ Make a Written Demand on Directors to bring suit or redress the injury and the demand is rejected.

Corporation has 90 days to respond unless waiting that long would cause irreparable injury.

The demand requirement used to be excused if doing so would be futile (still the case in many other states), but it is required modernly.

Futility would be evidenced where the majority of the Director's will be the Defendants in the suit.

4️⃣ Join the Corporation as a Defendant (technicality).

✅ Settlement or Dismissal of a Derivative Suit only possible with Court approval.

The Court may give notice to Shareholders to get their input on whether to dismiss or settle.

❌ Corporation can move to dismiss on the basis that independent investigation (b y independent directors or Court-appointed panel of 1 or more independent persons) showed the suit was not in the Corporation's bets interest (e.g., low chance of success or expense would exceed recovery).

In ruling on the motion, the Court will look to see if those recommending the dismissal are independent, and if so, dismiss.

In some states, the Court will also make an independent assessment of whether dismissal is in the Corporation's best interest.

⚖️ Shareholder Duties

⚖️ Shareholder's Duties to other Shareholders

In a Close Corporation, especially controlling Shareholders should not oppress minority Shareholders, e.g.., by selling control to people who loot the Corporation (without reasonable investigation of the buyer).

If there's oppression, a harmed minority Shareholder can sue the controlling Shareholder who oppressed them.

Courts let minority Shareholders sue in these situations, because a minority Shareholder in a Closely-held Corporation has no exit.

There is no market for the stock of a Closely-held Corporation.

⚖️ Close Corporation

Shareholders can eliminate the Board and run the Corporation directly in a Close Corporation, which is a Corporation with:

✅ A small number of Shareholders; and

✅ Stock is not publicly traded.

How is this done? Either

1️⃣ In the Articles or By-laws [approved by all Shareholders]; or

2️⃣ By unanimous written Shareholder agreement.

Either way, the agreement should be conspicuously noted on the front and back of the stock certificates.

In this "Extremely Rare" situation: The Shareholders are running the Corporation, and therefore owe the Director Duties of Care, Loyalty, Disclosure to the Corporation.

⚖️ Dissenter Appraisal Rights

A dissenting Shareholder to [any of the following: Merger or Consolidation, Transfer of substantially all assets not in the ordinary course of business, or transfer of shares in a share exchange, or an Amendment of the Articles that effectuates a reverse stock-split] may exercise their right to force the Corporation to buy them out at fair value.

❌ Right not available if the stock is listed on a national exchange; or has

❌ 2,000 or more Shareholders.

✅ So, in effect, the right of appraisal exists in Closely-held Corporations.

💡 The right may exist even without dissenting at an actual Shareholder Meeting - as in the case of a short-form merger.

To perfect the right:

1️⃣ Before Shareholder vote, file written notice of objection + intent to demand payment;

2️⃣ Abstain or vote against the proposed change; and

3️⃣ After the vote, within time set by Corporation, make written demand to be bought out and deposit stock with the Corporation.

If the Shareholder and the Corporation cannot agree on a fair value, the Court may appoint an appraiser.

This is the Shareholders' only remedy for these fundamental changes (absent fraud).

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Pre-incorporation acts by a Promoter

Promoters are persons acting on behalf of a Corporation that has not yet formed.

Prior to incorporation it is common for a promoter to raise capital and contract for a location, business materials, equipment, etc.

Liability for Promoter Contracts: Promoters are personally liable for pre-incorporation contracts until:

✅ There has been a novation (legal term that means legally effective substitution) replacing the promoter's liability with that of the Corporation; or

✅ There is an agreement between the parties that expressly states that the promoter is not liable.

Right of Reimbursement: The promoter may have a right to reimbursement based on quasi-contract for the value of the benefit received by the Corporation, or on the implied adoption of the contract.

A Corporation is not generally liable for, or bound to, pre-incorporation contracts except where the Corporation expressly:

✅ Adopts the contract; or

✅ Accepts the benefits of the contract.

Note: The promoter is also still liable unless there has been a novation (that is a legally effective substitution) or express agreement between the parties that the promoters will not be liable.

Promoter Duties: A promoter has a fiduciary relationship with the Corporation requiring good faith.

Promoters cannot make a secret profit on their dealings with the Corporation.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.

⚖️ Shareholder Liability

Bedrock Principle: Shareholders have limited liability [except in cases where the Court permits piercing of the Corporate Veil (PCV) which only occurs in closely-held Corporations.

⚖️ Piercing or Lifting the Corporate Veil

Generally, a corporate shareholder is not liable for the debts of a corporation, except when the court pierces or lifts the corporate veil and disregards the corporate entity, thus holding shareholders personally liable as justice requires.

It is easier to find liability in closely held corporations (those with few shareholders that make the decisions - that is, active shareholders).

The veil can be pierced for the following reasons:

1️⃣ Alter ego: Where the shareholders fail to treat the corporation as a separate entity, but more like an alter ego where corporate formalities are ignored and/or personal funds are commingled;

2️⃣ Undercapitalization: Where the shareholders’ monetary investment at the time of formation (and/or insurance coverage) is insufficient to cover foreseeable liabilities; some courts in close corporations look at future debts if foreseeable;

3️⃣ Fraud: Where a corporation is formed to commit fraud or as a mechanism for the shareholders to hide behind to avoid existing obligations; or

4️⃣ Estoppel: Where a shareholder represents that he will be personally liable for corporate debts.

The effect of piercing the corporate veil is that active shareholders will have personal joint + several liability.

💡 Issue-spotting tip: Where piercing or lifting the corporate veil is at issue, the facts often will also raise the issue of promoter liability for pre-incorporation contracts and breaches of fiduciary duties by directors.

This issue often arises in situations where there are few shareholders and courts are more likely to pierce the corporate veil for tortious acts and not for contract issues.

💡 Unlike a contract claimant, a tort victim did not voluntarily choose to transact with the Corporation and did not knowingly assume the risk of limited liability.

✅ Where either de facto Corporation or Corporation by Estoppel are indicated by the facts this may create a defence [Bail promoter out of a position of liability] for the promoter to avoid personal liability.

These 2 doctrines have been abolished in many states, but if they are available here is how they would work.

Where is the company incorporated or formed?

The “home" state where the corporation is incorporated as a domestic corporation determines which states laws apply to the internal affairs of the Corporation.

California is more liberal in allowing the corporate veil to be pierced than say Nevada where it is more difficult.

Totality of Circumstances

Factors that a court may consider when determining whether or not to pierce or lift the corporate veil include the following:

⚖️ Absence or inaccuracy of corporate records;

⚖️ Concealment or misrepresentation of members;

⚖️ Failure to maintain arm's length relationships with related entities;

⚖️ Failure to observe corporate formalities in terms of behavior and documentation;

⚖️ Intermingling of assets of the corporation and of the shareholder;

⚖️ Manipulation of assets or liabilities to concentrate the assets or liabilities;

⚖️ Non-functioning corporate officers and/or directors;

⚖️ Significant undercapitalization (or under insurance) of the business entity (capitalization + insurance requirements vary based on industry, location, and specific company circumstances);

⚖️ Siphoning of corporate funds by the dominant shareholder(s);

⚖️ Treatment by an individual of the assets of corporation as his/her own;

⚖️ Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings; alter ego theory;

Important: Not all of these factors need to be met in order for the court to pierce the corporate veil.

Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable.

For example: many large corporations do not pay dividends, without any suggestion of corporate impropriety, but particularly for a small or close corporation the failure to pay dividends may suggest financial impropriety.

Example is where a parent Corporation forms a subsidiary to avoid its own obligations. The Court may allow the piercing of the Corporate Veil, so the plaintiff may sue the parent Corporation (go after the parent Corporation's assets).

⚖️ Deep Rock Doctrine

When a corporation is deemed undercapitalized or insolvent, third-party or outside creditors may be paid off before the claim of a shareholder and esp. a shareholder with a controlling interest who makes a loan to his or her own corporation, thus subordinating the shareholder claims.

Credits:

This FAQ was prepared by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This FAQ is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.