978-1285860381 Chapter 33 Solution Manual Part 1

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Suggested Additional Assignments

Field Work: Selecting a State of Incorporation

Ask students to call two or three businesses—at least one large and one small– to find out where they are

incorporated. If students actually talk to someone who has started her own business, they should ask her

why she chose that particular state. Did she consider incorporating in another state? What factors most

influenced her decision?

Research: Corporate Names

Ask students to choose a name for a new corporation and then check with their Secretary of State’s office,

either by phone or on the Internet, to see if that name is available.

Research: Approval by Written Consent

In Delaware, shareholders and directors of a corporation can vote without holding a meeting simply by

signing a written consent. While in many other states the consent must be unanimous, Delaware requires

the same number of votes as would be required at a meeting. In other words, if majority approval is

required at a meeting, only a majority need sign the consent. Ask students to investigate the rule in other

states.

Chapter Overview

Chapter Theme

Entrepreneurs often become impatient with the legal technicalities required to form and maintain a

corporation. However, these legalities can have a profound impact on the success of the business.

Quote of the Day

“CORPORATION, n. An ingenious device for obtaining individual profit without individual responsibility.”

–Ambrose Bierce (1842-1914?), American writer, from The Devil’s Dictionary.

Before the Corporation is Formed

Promoter’s Liability

The person creating the corporation, the promoter, may execute contracts on behalf of the business before

the corporation has been formed. The promoter is personally liable on such contracts. The corporation is

liable for a pre-formation contract only if it adopts the contract. Adoption involves both assignment of

the contract by the promoter to the corporation, and the corporation’s formal decision to accept the

assignment and adopt the contract. The promoter is still liable on the contract even after the corporation

adopts it unless the other party agrees to a novation limiting the promoter’s liability.

Defective Incorporation

De Jure Corporation

“De jure” is Latin for “by law.” A de jure corporation means that the promoter has substantially complied

with the requirements for incorporation, but has made some minor error. He has perhaps misspelled the

name of the corporation’s registered agent (more about the registered agent later). In this case, no one, not

even the state, can challenge the validity of the corporation.

De Facto Corporation

“De facto” is Latin for “in fact.” A de facto corporation means that the promoter has made a good faith

effort to incorporate and has actually used the corporation to conduct business.

Corporation by Estoppel

A corporation by estoppel means that, if a party enters into a contract believing in good faith that

the corporation exists, he cannot later take advantage of the fact that it does not.

You Be the Judge: GS Petroleum, Inc. v. R and S Fuel, Inc. 1

Facts: On March 13, GS Petroleum (GS) signed an agreement to sell a Shell gas station to R and S

Fuel, Inc. (Fuel). On April 2, Fuel opened a corporate bank account and began writing checks on it.

On April 15, Fuel took possession of the Shell station. Later, it took out insurance in the company’s

name. Unfortunately, what Fuel did not do was pay the money it owed under the contract.

So far, this looks like just a breach of contract case. But there is one more fact that greatly

complicates this simple picture: Fuel did not actually come into existence until March 27th, two

weeks after the contract was signed. The introduction to the contract stated that it was “entered by

and between R and S Fuel, Inc., and GS Petroleum, Inc.” The signature lines at the end looked like

this:

R And S Fuel Inc. Buyer

Susan Stamm and Richard Simpson

GS filed suit for $124,000 against the corporation but also personally against Richard Simpson and

Susan Stamm. The two individuals filed a motion for summary judgment.

You Be the Judge: Were Simpson and Stamm personally liable for the debts of Fuel?

Argument for GS: The corporation did not exist when the contract was signed, so someone else has

to be liable. Simpson and Stamm were the promoters, their names appear on the contract and

Simpson actually signed it. No corporate title is attached to his name on the signature line, which

indicates he was signing as an individual, not a corporate officer. And when Simpson signed the

contract, he was acting as Stamm’s agent. So she is liable, too.

The defendants argue that the business was a de facto

corporation, but they need to read the textbook more carefully. To qualify, they must have made a

good faith effort to comply with corporate law, but here they had not bothered to file the forms with

the Secretary of State. That is not a good faith effort.

While they are reviewing the text, Simpson and Stamm should

also note that even if Fuel adopted the contract, they are still liable until the parties sign a novation.

That did not happen here. And no provision of the contract explicitly or impliedly released the two

defendants.

To find Simpson and Stamm liable is the only fair result. Someone

is going to be out a lot of money. It should be the people responsible for losing that money – not the

innocent party who sold them a perfectly good business.

Argument for Simpson and Stamm: It is true that Simpson’s signature line did not list a corporate

title, but that was simply an oversight. He was clearly signing for the corporation. As for Stamm,

she cannot be liable for an agreement she did not sign.

Promoters who sign an agreement on behalf of a corporation are only liable if the parties intended

that result. GS entered into this agreement with a corporation. Note that the document states it is

an agreement with just Fuel; not Fuel, Simpson and Stamm. Everyone understood that to be the

1 2009 Del. Super. LEXIS 200 SUPERIOR COURT OF DELAWARE, 2009.

case. GS has not alleged that Fuel was a sham corporation. Even before the corporate documents

were filed, Simpson and Stamm ran the business as a corporation. They opened a bank account in

the company’s name, they used only business checks, they bought insurance in the corporate name.

If GS wanted the two individuals to be liable, the document should have said so.

Also, R and S Fuel was a de facto corporation at the time the Agreement was signed. Simpson and

Stamm were in the process of organizing it, they were making a good faith effort and they were

using the corporation to conduct business. In the case of a de facto corporation, third parties such

as GS have no right to challenge its validity.

Holding: The court ruled that the parties had not intended Simpson and Stamm to be liable, so they

were not.

Question: What is a de facto corporation?

Additional Case: Payer v. The SGL Carbon, LLC2

Facts: Edward Payer negotiated a purchase a sale agreement to buy a parcel of land in Niagara Falls,

New York from SGL for $2 million. Payer specified that the buyer in the contracted be listed as

“Transition Metals Technology, Inc. a new Jersey corporation. Payer signed the contract as CEO of

Transition but the company was never formed until one month after this lawsuit was filed. Payer claims

that SGL knew that Transition did not exist, but SGL claims that it did not. Ultimately, both parties had a

disagreement and SGL sold the land to someone else. Payer sued for breach of contract. SGL argued that

the contract was invalid because Transition was not in existence at that point.

Issue: Is a contract valid if signed by a corporation that did not legally exist at the time?

Holding: Judgment for Payer. The Court applied corporation by estoppel here. It held that the contract

with Transition was enforceable even though Transition did not exist when Payer signed the contract for

the reasons set out under Payer’s argument. Essentially, Transition’s corporation status was not important

to SGL – as long as the check was good, it did not matter who signed it.

Question: What is corporation by estoppel?

Answer: Corporation by estoppel is the doctrine that if a party enters into a contract believing in

Question: Did SGL believe in good faith that Transition Metal existed when it entered into the

purchase and sale?

Question: Why does the court think this point is not relevant?

Answer: It might be different if Payer had gone through with the contract and not paid SGL. Under

those circumstances, the court may think differently about the status of the corporation, and whether

General Question: Is the result in this case fair?

2 2006 U.S. Dist. LEXIS 68194, United States District Court for the Western District of New York, 2006.

Incorporation Process

Where to Incorporate?

Companies generally incorporate in their home state or in Delaware (or, possibly, Ohio, Pennsylvania, or

Nevada).

Question: If students completed the assignments on selecting a state of incorporation. Draw a chart

on the board, listing the different states and the reasons for their selection. Do the results show any

patterns?

Answer: It may be that small owners are more likely to incorporate in the state in which they are

Research: Corporate Names

If students completed the corporate names research, how many found that the names they chose were

unavailable?

Charter’s Optional Provisions

Director Liability

Case: Rodriguez v. Loudeye Corporation3

Facts: Loudeye Corporation provided digital music for cell phones and other consumer electronics.

Loudeye was headquartered in Seattle, Washington, but incorporated in Delaware. As is permitted under

Delaware law, Loudeye had an exculpatory clause in its charter protecting directors from liability.

Washington corporate law would not enforce such a clause.

Loudeye’s directors decided to sell the company because it was not generating enough revenue to

compete. At the time, the market price for the company was $1.66 per share. Nokia offered to pay $4.50

per share and Loudeye counteroffered at $5.00, which Nokia rejected. After two other companies

submitted lower offers, Loudeye’s board voted to accept Nokia’s bid.

Eli Rodriguez, a Loudeye shareholder, sued claiming the directors had breached their fiduciary duties by

failing to obtain the best price, and that the board had conflicts of interest and had approved the sale

because they would receive special financial benefits (such as severance payments and stock options).

The Loudeye directors filed a motion to dismiss alleging the exculpatory clause in the company’s charter

protected the directors from liability. Rodriguez argued that Washington law should apply, and even if the

exculpatory clause were valid, it did not apply in this case. The trial court granted the motion to dismiss.

Issues: Which state law applies to a company that is headquartered in Washington but incorporated in

Delaware? Does the exculpatory clause in the Loudeye charter protect its directors from liability?

Holding: The trial court’s dismissal is affirmed. Delaware law applies and the exculpatory clause in the

charter protects the directors from liability. According to the court, shareholder claims involving a

corporation’s internal affairs are governed by the laws of the state where it is incorporated. Because

Loudeye is a Delaware corporation, the laws of Delaware apply.

The conduct of the directors amounts only to a breach of due care which is not actionable against a

company with an exculpatory clause. Only allegations establishing a breach of the duty of loyalty or the

duty of good faith can survive a motion to dismiss.

To establish a breach of the duty of good faith, Rodriguez must show that the director’s conduct was

motivated by an actual intent to do harm, or the directors consciously and intentionally disregarded their

responsibilities, and is conduct so far beyond the bounds of reasonable judgment that there is no other

explanation for the conduct other than bad faith.

3 2008 Wash. App. LEXIS 767, Court of Appeals of Washington, 2008.

According to the court, disloyalty is usually implicated when the directors in the acquired corporation also

have interests in the acquiring corporation or when directors seek to entrench themselves in their positions

of control. Neither situation is present here. The complaint fails to state a claim for breach of the duty of

loyalty or good faith.

Question: Why did Loudeye include an exculpatory clause in its charter?

Question: Does this benefit anyone other than the director?

Answer: Yes, it benefits the company too. If directors are free from personal liability except in cases of

bad faith and intentional wrongdoing, they may feel freer to make risky decisions for the good of the

Cumulative Voting

In a cumulative voting system, a shareholder can pool his shares and vote them all for the same person.

A dissident shareholder battling company management is more likely to be elected to the board of

directors in a company with cumulative voting. Thus, to put a damper on dissidents, many companies

changed their charter after the Pickens-Gulf Oil battle to eliminate cumulative voting. Because some state

corporation laws required cumulative voting, companies in those states that wanted to eliminate

cumulative voting also had to change to a different state of incorporation.

Question: Does cumulative voting favor management or shareholders?

Question: Why did Gulf Oil have cumulative voting?

Answer: Because the state of Pennsylvania required cumulative voting and this system had never

Question: Can you make an argument that cumulative voting is bad for shareholders too?

Answer: Managers often argue that cumulative voting harms shareholders because:

Drafting Exercise: Start-Up Corporation

Give students the following set of facts, and then ask them to break into groups to draft a corporate

charter for this business:

Lou is a computer programmer at a high-tech company. Dora works as assistant chief financial

officer at the same company. They would like to start an automated grocery business. Their plan is

to have a large warehouse on the outskirts of the city. Customers would e-mail or fax their orders

any day before 3 P.M. A computerized retrieval system would gather the groceries. Trucks would

deliver them to central drive-in retrieval points by 5:00 P.M. so that commuters could pick them up

on their way home from work. The heart of the program is the computerized retrieval system, which

Lou is currently developing. Dora’s role will be to raise (substantial) capital and manage all aspects

of the company except product development. Their plan is to develop similar stores all over the

country. (A sample charter for Delaware is available at http://www.state.de.us/corp/.)

Question: What issues should Lou and Dora consider?

Answer:

Name. After choosing a name, they must remember to check with the Secretary of State’s

Stock. They will want to authorize as many shares as they can for the basic filing fee.

[While checking with the Secretary of State’s office, students could also find out how many

Indemnification. They will want to indemnify the officers and directors.