978-1285860381 Chapter 33 Solution Manual Part 2

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After Incorporation

Research: Approval by Written Consent

Instead of holding a meeting to approve a decision, directors and shareholders can simply sign a

written consent.

Question: If students completed this research project, ask them now what they found out about

written consents.

Question: Why does this issue matter?

Answer: It is not uncommon for the officers in a small company to fail to prepare all the required

consents (or hold the required meetings). If the company later wants to undertake a transaction with

Bylaws

The bylaws establish the rules for the day-to-day conduct of the corporation’s affairs.

Case: In Re Bigmar1

Facts: Cynthia May was Bigmar’s president and a director of the company. She took control of the

company’s financial records and refused to give the company’s founder, John Tramontana, any

information. With the company in desperate financial shape, Tramontana managed to find a bank

willing to buy $1 million of Bigmar stock. He called a special meeting of the board of directors to

approve the sale of shares and to fire May. The meeting was to take place by telephone. To establish a

quorum necessary for the meeting to be valid, at least five of the nine directors would have to take part.

May and her three allies on the board refused to participate.

Tramontana testified that, at the appointed time, he met with two directors in his office. They used

a speaker feature on a cell phone to call two other directors, one of whom was in Heathrow airport in

London. The five directors unanimously resolved to issue the stock to the bank. Tramontana and May

went to court to determine if the directors’ meeting was valid and the bank entitled to the shares.

Issue: Was the meeting of the Bigmar board of directors valid?

Holding: Although the meeting took place, it was not valid. The bylaws required a quorum of five

directors. Only four directors were present, the fifth was en route from London to Ireland. Tramontana

thought he could simply get this fifth director to sign a written consent but then he discovered that any

decision taken by written consent required the unanimous approval of all the directors. At that point,

Tramontana decided to say that the fifth director had been present by cell phone, but there were no

telephone records to support this statement.

Question: Why did Tramontana call a directors meeting?

Question: Why did May and her faction refuse to attend the meeting?

Question: What were the quorum requirements for a directors meeting?

Question: Were five directors present?

1 2002 Del. Ch. LEXIS 45 Court of Chancery, Delaware, 2002

Question: For a written consent to be valid, how many directors had to sign?

Question: Did Tramontana know this interesting fact?

Question: Was the court sympathetic to Tramontana?

Question: Then why did the court hold that the meeting was invalid?

Foreign Corporations

A company is called a domestic corporation in the state where it incorporates and a foreign corporation

everywhere else. States require foreign corporations doing business within their borders to register

with them and obtain a certificate of authority. This registration process is called qualifying to do

business. Under the Model Act, a company that is doing business without qualifying cannot bring a

lawsuit in that state until it registers.

Death of the Corporation

Piercing the Corporation Veil

A court may hold the shareholders of a corporation liable for the debts of the corporation if:

The company fails to observe formalities

Shareholders commingle their assets with those of the corporation

The company is inadequately capitalized, or

The shareholder uses the company to commit fraud.

Case: Azte Inc. v Auto Collection, Inc.2

Facts: Auto Collection, Inc. (Auto) operated a used car dealership that sold luxury vehicles to buyers

in Eastern Europe. Steven Lever owned 90 percent of Auto; his wife and their son, Joshua, each owned

5 percent. Steven controlled Auto’s finances, including its bank accounts, checkbook, and bookkeeping

records. While Steven generally maintained appropriate, separate corporate records, the address listed

on Auto’s bank account was his personal address, not Auto’s place of business.

Steven initially capitalized Auto with a few thousand dollars, but afterwards was not sure of the exact

amount because he contributed funds as needed. He also claimed to have loaned $900,000 to Auto, but

there was no documentation. He deposited and withdrew money from Auto’s bank account at his sole

discretion.

At one point, Auto stopped delivering cars, even ones that were paid for. Customers began demanding

refunds. Meanwhile, Joshua started work for his father. During his year at Auto, he was paid $474,850,

at a time when the company owed significant funds to its customers.

AZTE, Inc. and the other plaintiffs paid more than $500,000 for several cars they never received. The

plaintiffs filed suit against Auto, Steven, and Joshua.

Issue: Should the court pierce Auto’s corporate veil? Are Steven and Joshua personally liable for

Auto’s debts?

Excerpts from Judge’s Demarest’s Decision:

Piercing the corporate veil, while generally disfavored as incompatible with the protection

afforded business owners from personal liability for the failings or transgressions of the

corporate entity, is an equitable remedy designed to protect creditors or other victims from a

2 > Rice v. Oriental Fireworks Co., 75 Or. App. 627 (Or. Ct. App. 1985).</

fraudulent design by such owners to thwart recovery from the corporation for legitimate debts

or injury. Even where outright fraud is not established, where a corporation is so dominated by

its principal that its separate identity has been ignored, such that the principal’s interests take

precedent over and control the business purpose of the corporation, and the corporation thus

becomes the alter ego of the individual, the corporate veil may be pierced to avoid injustice.

By virtue of his sole and exclusive control of all record keeping, Steven was aware of, and

controlled, every transaction. As Steven openly admitted, he owned Auto and treated its assets

and resources as his own. [H]e freely transferred Auto funds into his own personal bank

account. This practice is the essence of commingling, self-dealing and disregard of the

corporate form.

Steven ignored a number of corporate formalities, including the use of his personal address on

Auto’s bank statements and the failure to create loan documents with respect to the money he

deposited into Auto.

This court finds that Steven used his complete domination over Auto to prevent AZTE [and the

other plaintiffs] from receiving either automobiles in exchange for their payments or a refund

and, as a proximate result, [the plaintiffs] were damaged, justifying the piercing of the

corporate veil to hold him liable for the corporation’s debt.

[T]here is insufficient evidence, however, to pierce the corporate veil as to Joshua. Joshua was

involved in the day to day operations of Auto and had the same access to the bank accounts and

books and records of Auto as Steven. However, there was insufficient evidence to establish that

Joshua, a mere 5% owner of Auto, otherwise owned and controlled by his father, treated the

corporation as his alter ego. There was no evidence that Joshua, like Steven, ignored corporate

formalities; Joshua did not receive the bank account statements at his personal address or issue

loans to the corporation without any form of documentation. There was no evidence that Joshua

commingled the assets of Auto with his own or used Auto’s assets for his personal purposes.

Although Joshua was paid over $100,000 for only a few months’ work, such salary may well be

justified. This payment alone, for services rendered, is insufficient to hold Joshua personally liable for

the judgment against Auto.

Question: What type of remedy is piercing the corporate veil?

Question: What is piercing the corporate veil designed to do?

Answer: It is designed to protect creditors or other victims from a fraudulent design by such owners

Multiple Choice Questions

1. CPA QUESTION Generally, a corporation’s articles of incorporation must include all of the

following except the:

(a) Name of the corporation’s registered agent

(b) Name of each incorporator

(d) Quorum requirements

2. CPA QUESTION Destiny Manufacturing, Inc., is incorporated under the laws of Nevada. Its

principal place of business is in California, and it has permanent sales offices in several other

states. Under the circumstances, which of the following is correct?

(a) California may validly demand that Destiny incorporate under the laws of the state of

California.

(b) Destiny must obtain a certificate of authority to transact business in California and the other

states in which it does business.

(d) California may prevent Destiny from operating as a corporation if the laws of California differ

regarding organization and conduct of the corporation’s internal affairs.

3. CPA QUESTION A corporate stockholder is entitled to which of the following rights?

(a) Elect officers

(b) Receive annual dividends

(d) Prevent corporate borrowing

4. Participating preferred stockholders:

(a) only receive payment after other preferred shareholders have been paid

(b) only receive payment after common shareholders have been paid

(d) receive all their payments before all other shareholders

5. Which of the following statements is/are true?

(a) Shareholders can amend the bylaws

(b) Directors can amend the bylaws

(d) Both (a) and (b)

Case Questions

1. Michael incorporated Erin Homes, Inc., to manufacture mobile homes. He issued himself a stock

certificate for 100 shares for which he made no payment. He and his wife served as officers and

directors of the organization, but, during the eight years of its existence, the corporation held only

one meeting. Erin always had its own checking account, and all proceeds from the sales of mobile

homes were deposited there. It filed federal income tax returns each year, using its own federal

identification number. John and Thelma paid $17,500 to purchase a mobile home from Erin, but the

company never delivered it to them. John and Thelma sued Erin Homes and Michael, individually.

Should the court “pierce the corporate veil” and hold Michael personally liable?

Answer: The appeals court pierced the corporate veil and held the shareholder liable because the

2. Angelica is planning to start a home security business in McGehee, Arkansas. She plans to start

modestly but hopes to expand her business within 5 years to neighboring towns and, perhaps,

within 10 years to neighboring states. Her inclination is to incorporate her business in Delaware. Is

her inclination correct?

3. The Resolution Trust Corp. (RTC) sued the directors of the Commonwealth Savings Association

seeking to recover from them personally $200 million that the bank lost in bad real estate loans.

The directors approved the loans after state and federal regulatory agencies had issued reports

criticizing the bank’s loan practices. The directors failed to implement policies and procedures to

prevent problems with the loan portfolio and failed to monitor loan officers adequately. There was

no evidence that the directors knowingly committed illegal acts or acts outside their authority.

Under Texas law, the RTC could recover for the directors’ negligence only if their acts were ultra

vires. Were these acts ultra vires?

Answer: The court ruled that the directors’ activities were ultra vires only if they had deliberately

4. Waste Management, Inc., the country’s largest waste hauler, changed its name to WMX

Technologies, Inc. Similarly, U.S. Steel changed its moniker to USX Corp. and American Airlines

became AMR Corp. What legal steps would be necessary to protect the new corporate names?

Answer: It would have to amend its charter in its state of incorporation. It would also have to

5. Dickens, Inc. is a bookstore incorporated in Nevada. From its warehouse in Montana, it ships

books to all 50 states. The company’s owner lives in New York, its web designer lives in

California. Where is Dickens a domestic corporation? Where must it qualify to do business?

Answer: It is a domestic corporation in Nevada. It must qualify to do business in Montana, because

Discussion Questions

1. Facebook’s charter has an exculpatory clause, which protects directors from liability unless they

act in bad faith or they intentionally engage in wrongdoing. Is that a reasonable standard?

2. Facebook, Inc. (and other Internet companies) have created dual classes of stock so that the

founders can continue to control their company long after it goes public or they die. Should

corporate laws permit this? If the founders want to control a company, why shouldn’t they buy

enough regular stock to do so?

3. When Facebook went public, its disclosure document said:

As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and

must act in good faith in a manner he reasonably believes to be in the best interests of our

stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to

vote his shares in his own interests, which may not always be in the interests of our

stockholders.

Should corporate laws permit Zuckerberg to control the company without a duty to act in the best

interests of the other shareholders?

4. ETHICS In the Bigmar case, the court clearly believed that the directors had lied on the witness

stand. Should the directors have been charged with perjury? Did they do the right thing when they

lied on the stand to protect their company from the evil Ms. May? What would Mill and Kant have

said?

5. States compete for lucrative filing fees by passing corporate statutes that favor management. One

proposed solution to this problem would be a federal system of corporate registration. Is this a

good idea? What are the impediments to such as system?

Answer: It would also solve the problem of qualifying to do business in other states. Under a