Chapter 20
CORPORATIONS
1
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
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
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.
Promoter’s Liability
The person creating the corporation, the promoter, may execute contracts on behalf of the business before
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
2 Unit 4 Business Organizations
The Charter
A corporate charter must generally include the company’s name, address, registered agent, purpose, and a
description of its stock.
Research: Corporate Names
If students completed the corporate names research, how many found that the names they chose were
unavailable?
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
Question: What issues should Lou and Dora consider?
Answer:
• State of Incorporation. Venture capitalists may insist upon Delaware. In addition, Delaware is
probably the right choice if their business will go national.
• Name. After choosing a name, they must remember to check with the Secretary of State’s office
• Purpose. The purpose clause should be broad enough to ensure that they will not have ultra vires
problems if they expand the business.
• 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 shares they
can authorize for the basic filing fee.] They must also select a par value. Will they need different
classes? Perhaps the venture capitalists will want their own class, which is entitled to elect a
Chapter 20 Corporations 3
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
Bylaws
The bylaws establish the rules for the day-to-day conduct of the corporation’s affairs.
Additional 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
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?
Answer: They were a minority and could not prevent the majority from firing her.
1 2002 Del. Ch. LEXIS 45 Court of Chancery, Delaware, 2002
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Question: Were five directors present?
Answer: No, the fifth director, who would have been present by telephone, was stuck in transit
Question: For a written consent to be valid, how many directors had to sign?
Answer: All nine of them had to sign.
signed.
Question: Was the court sympathetic to Tramontana?
Question: Then why did the court hold that the meeting was invalid?
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: Brooks v. Becker2
Facts: Becker Interiors, Inc. was overseeing the major renovation of a house. Becker Interiors hired
Stephen Brooks as a subcontractor on the project. When the corporation refused to pay him, Brooks sued
it.
Ronald Becker was the sole shareholder, officer, and director of Becker Interiors. Becker and his
$54,597.09. When Brooks tried to collect the judgment, he discovered that Becker Interiors had no
assets.
Issue: Can Brooks pierce the corporate veil? Is Becker personally liable for the debts of the corporation?
Holding: Judgment for Brooks against Becker for $54,597.09. Piercing the corporate veil is an
extraordinary remedy, warranted only when the shareholder used the corporation to evade a personal
obligation, perpetrate fraud, commit an injustice, or gain an unfair advantage. Holding the shareholder
liable is justified only when the activities of the corporation and the shareholder are so joined that it is
difficult to tell the two apart. In this case, there was no legitimate rationale for Becker’s commingling of
corporate funds with his personal funds.
Question: Against whom did Brooks obtain a judgment?
Chapter 20 Corporations 5
Answer: Ronald Becker had used corporate funds to renovate his house, pay his credit card bills and
invest in another company of which he was president. He deposited corporate checks into his personal
bank account.
Answer: A corporation is a separate legal entity that must stand on its own feet legally. It must use its
assets to pay its debts before it enriches its shareholders. In short, a shareholder is shielded from the
debts of the corporation only if the assets of the corporation are used to pay those debts. Ronald
Becker wanted to have it both ways – he wanted to use the assets of the corporation for personal
expenses but then not be personally liable for corporate debts.
Question: Do courts often pierce the corporate veil?
Answer: No. Only under extraordinary circumstances.
The Role of Corporate Management
The courts have generally held that managers have a fiduciary duty to act in the best interests of the
corporation’s shareholders. Does the law permit—or require—directors to consider the best interests of
other stakeholders?
Additional Case/Landmark Case: Unocal Corp. v. Mesa Petroleum Co.3
Facts: Mesa Petroleum Co. offered to purchase 64 million shares of Unocal’s stock at a price of $54 per
share. Upon merger of the two companies, Mesa planned to exchange the remaining Unocal shares for
“junk bonds” that Mesa (but no one else, including the court) valued at $54 per share. Unocal’s
included Mesa.
Issues: Could Unocal make an offer to buy stock from all shareholders except Mesa? In making this
offer, did Unocal have the right to consider the interests of other stakeholders?
Holding: The court upheld Unocal’s right to offer a selective stock repurchase on the following grounds:
• The board had a fiduciary duty to act in the best interests of the corporation’s shareholders.
• The board could not offer the selective stock repurchase simply to perpetuate itself in office, but
in making the offer, it could consider the interests of other constituencies, such as creditors,
customers, employees, and even the community generally.
6 Unit 4 Business Organizations
Question: Why did the board care if Mesa took over the company?
Answer: Pickens (the Mesa CEO) would have replaced the board of directors. In addition,
Pickens was a controversial figure. He had been involved in the abortive effort to take over Gulf
• It could consider the interests of other constituencies, such as creditors, customers, employees,
and even the community generally.
• It could also consider the interests of long-term investors over short-term speculators.
Question: Did it act in the best interests of the corporation’s shareholders?
Answer: Shareholders clearly preferred the company’s $72 per share offer to Mesa’s
excluded it.
Question: What about the other stakeholders the court mentions: creditors, customers,
employees, and the community?
Answer: These stakeholders would probably prefer to maintain their stable relationships with
Question: Why would the community care?
Answer: Because Mesa would probably move company headquarters and fire employees. For
Question: Traditionally, under corporate law, the board’s primary responsibility was to act in the
best interests of the corporation’s shareholders. Since when is the board supposed to consider
other stakeholders and long-term investors over short-term speculators?
Answer: Good question. There really is no precedent for this decision in corporate law. The
Question: Was the board really acting out of concern for shareholders and stakeholders?
Answer: That is the problem with all the takeover cases. It is hard to dismiss the belief that the
board is hiding behind the stakeholders to protect itself. It would be unacceptably greedy for the
board and top officers to say, “Look, I like my job here. I am well-paid, and have lots of perks.
The Business Judgment Rule
Self-Dealing
Self-dealing means that a manager makes a decision benefiting either himself or another company with
which he has a relationship.
Chapter 20 Corporations 7
Additional Case: Lippman v. Shaffer4
Facts: Harry Lippman’s son, James, had two children, Wade and Amy. Years ago, Harry purchased
Despatch Industries, Inc., which manufactured hardware for cabinets. James worked for the company
until he retired. In 1975, when Wade graduated from college, he joined the family business. Amy’s
husband Alan Shaffer joined the business in 1982. In 1993 Wade and Alan signed identical employment
The business judgment rule does not apply when directors have an interest in a challenged
transaction, such as when they will receive a direct financial benefit from the transactions that is different
from the benefit to shareholders generally. Here, the business judgment rule does not apply. Wade
established that there was no contractual or other legitimate reason for the severance payment to Alan
because he was still working for the company. To avoid liability, the board will have to show fairness by
presenting evidence of the manner by which it otherwise discharged all of its fiduciary duties. However,
it is undisputed that no events transpired to trigger the payment to Alan. Alan stated “Whatever Wade
got, I would get. Whatever I got, Wade would get.” Because a severance payment was contractually due
to Wade and not to Alan, Alan’s payment was a gift of corporate assets, and therefore he got more that
Wade.
Question: What is a fiduciary duty?
Question: If managers act in the best interest of the shareholders, are they protected by the business
judgment rule?
Answer: Generally, the business judgment rule will protect managers when they make decisions in
Question: Is that what happened with Despatch?
Answer: The court said that although Despatch had a contractual obligation to pay Wade his
$1.3 million, Alan received more than Wade received.
Question: What should Despatch have done to protect itself from liability?
the severance payment to Wade.
Question: Was this transaction entirely fair?
Answer: Although James Lippman may have thought he was being fair to his son and son–in-law, as
4 15 Misc. 3d 705, 836 N.Y.S.2d 766, 2006 N.Y. Misc. LEXIS 4212, Supreme Court of New York, 2006.
8 Unit 4 Business Organizations
Corporate Opportunity
Managers violate the corporate opportunity doctrine if they compete against the corporation without its
consent. However, even if managers do not seek permission in advance, they are not in violation of the
corporate opportunity doctrine if they can demonstrate after the fact that the company would not have
been able to benefit from the opportunity.
Case: Anderson v. Bellino5
Facts: At the request of the city of LaVista, Nevada, Richard Bellino and Robert Anderson formed
LaVista Lottery, Inc. to operate a restaurant and lounge with a keno game. Over the next nine years, the
Lottery company grossed more than $100 million. Bellino and Anderson each received over $4 million in
salary and dividends. Bellino spent more time than Anderson working for the company, in part, because
Issues: Did Bellino usurp a corporate opportunity? Is he liable to Lottery?
Holding: Judgment for Anderson and Lottery affirmed. Bellino and Keno claim that if a corporate
opportunity existed, it was limited to the opportunity to bid on the keno contract and that Bellino did
nothing to impede Lottery from bidding. In fact, the corporate opportunity was the contract itself, not just
the right to bid on it. Bellino should not have competed with Lottery.
Question: What is keno?
Question: Was this a profitable business?
Answer: The company grossed more than $10 million a year. The two owners – Bellino and
Anderson – each netted almost half a million dollars a year.
Question: Did Bellino discuss his concerns with Anderson?
Answer: Not exactly.
Answer: He encouraged the city to put the keno license out to bid. He formed his own company and
bid on the license. He won the bidding.
Question: Is there anything wrong with that?
Question: What is the point of this doctrine?
5 265 Neb. 577; 658 N.W.2d 645; 2003 Neb. LEXIS 49 Supreme Court of Nebraska, 2003
Chapter 20 Corporations 9
Question: But both Bellino and Anderson had a chance to bid on the keno contract. Didn’t they both
have the same opportunity?
Answer: The court held that the opportunity was running the keno game not just the right to bid on
Additional Case: Northeast Harbor Golf Club, Inc. v. Harris6
Facts: Nancy Harris was the president of the Northeast Harbor Golf Club in Maine for nearly 20 years.
The club’s only major asset was a golf course in Mount Desert. Harris was definitely a generous
president. She not only mowed the grass and did the gardening, she also used her own money to purchase
equipment for the club. Twenty years ago, a real estate broker informed Harris that three parcels of land
next to the golf course were for sale. The agent contacted Harris because she was the president of the
club and he believed that the club would be interested in buying the property to prevent development.
Harris immediately agreed to purchase the property in her name. Afterwards, she informed the club’s
board that she had made the purchase and that she did not intend to develop the land. Again, 15 years
ago, Harris purchased a parcel of land contiguous to the golf course. Again she informed the board of
directors after the purchase.
Issue: Did Harris violate the corporate opportunity doctrine?
Holding: Judgment for Harris reversed. Instead of determining on her own that the club could not afford
the land, Harris should have given the board the opportunity to make that decision. Although the club
was in the business of operating a golf course, owning land was an inherent part of that business. Harris’s
new development could have infringed on the value of the club’s land and its ability to operate the course.
However, the SJC ordered the case dismissed because the statute of limitations had run out before the
club filed suit.
Question: Did Harris compete with the golf course?
• Harris should have given the board the opportunity to determine if the club could afford the land.
Question: To what damages would the club be entitled?
Question: Is that what the club wants?
Answer: Probably the club would prefer that the property not be developed at all. In other words, it
6 1999 ME 38, 725 A.2d 1018, 1999 Me. LEXIS 36 Maine Supreme Judicial Court, 1999
10 Unit 4 Business Organizations
Duty of Care
Rational Business Purpose
In the Wrigley case, the court held that the company did have a rational business purpose. One
commentator suggested that finding a case in which a court held that a board decision did not have a
Duty of Care/Informed Decision
Additional Case: RSL Communications v. Bildirici7
Facts: Ronald S. Lauder founded RSL, Ltd. A multinational telecommunications corporation that
provided voice, mobile, and data/internet services. RSL Plc was a subsidiary of RSL Ltd. The subsidiary
began issuing $1.4 billion of bonds. A few years later, in July, Lauder provided RSL Plc with a $100
million line of credit. The company’s board did not hold a meeting to approve the line of credit, but in
August drew down $25 million from the loan. The following March, the company’s board held their first
meeting in a year. Five days later, RSL, Plc filed for bankruptcy.
The issue before the court is whether the members of the board of directors of RSL Plc breached their
When faced with allegations of misconduct, a director may raise the business judgment rule as a
defense. The business judgment rule applies even where conclusions were stupid or irrational, as long as
the process employed was either rational or employed in a good faith effort to advance the corporation. A
director must show an exercise of judgment, not simply the existence of a business decision. Thus, where
the director’s methodologies and procedures are so halfhearted or restricted in scope as to constitute a
pretext or a sham, their acts are not protected by the business judgment rule.
RSL Plc did not hold board meetings on behalf of RSL Plc during the time period relevant here.
Despite this, RSL Plc still operated and took actions such as drawing down $25 million from the loan,
apparently at the direction of RSL Ltd. However, no independent board meeting or discussions regarding
the propriety of this and other business decisions were held on behalf of RSL Plc.
The law does not tolerate inaction of this sort. RSL Plc allegedly failed to consider any information
regarding the company’s financial health and allegedly failed to make a business judgment as a board
7 2006 U.S. Dist. LEXIS 67548, United States District Court for the Southern District of New York, 2006.
Chapter 20 Corporations 11
Lastly, RSL Plc argues that its board members were fully informed about the financial situation of the
company because some RSL Plc board members were also RSL ltd board members, and thus they
exercised their judgment on behalf of RSL ltd, the parent of RSL Plc. However, individuals who act in a
dual capacity as directors of parent and subsidiary corporation owe the same duty of good management to
both corporations.
Question: The board members of RSL Plc and RSL Ltd overlapped. RSL Plc claims that because of
this overlap, both boards were aware of what was going on with RSL Plc. Shouldn’t that make a
difference when determining whether the board of RSL Plc was making an informed decision?
Answer: The court does not think so. The court expressly rejected that argument, stating that it
Question: Does the fact that the board did not formally meet to discuss the loan or the draw down
mean that the members acted improperly?
Answer: Not necessarily. What the court said was that because the board did not meet, the directors
failed to follow proper procedure. Because the directors are faced with allegations of misconduct, in
Role of Shareholders
In many ways, this chapter is as much about ethics as Chapter 2. Corporate managers have a great deal of
power and, as the Enron case and other corporate scandals have illustrated, some have abused this power.
Research: Board of Directors
If students performed this assignment on boards of directors, they could discuss what they found.
General Questions:
• What percentage of directors were insiders versus outsiders?
Rights of Shareholders
As a shareholder you have neither the right nor the obligation to manage the day-to-day business of the
enterprise.
Right to Information
Under the Model Act, shareholders acting in good faith and with a proper purpose have the right to
inspect and copy the corporation’s minute book, accounting records, and shareholder lists.
Additional Case: You Be The Judge: Chopra v. Helio Solutions8
Facts: Facts: Paul Chopra was a minority shareholder and former director of Helio Solutions, Inc. Both
12 Unit 4 Business Organizations
at an excessive rent, (2) the company had broken a lease so that it could rent this building, (3) some
shareholders had used assets of the corporation to secure a personal loan, (4) Helio had permitted ex-
employees to take away substantial business, and (5) the company had not collected a $1 million debt it
was owed. In addition, he wanted to know if Helio was planning to issue stock and thereby dilute his
ownership. Finally, he felt that his dividend of $1952.55 was unreasonably low, given that Helio had $88
million in revenue. Chopra hired a forensic accountant to help him investigate Helio’s finances. At the
accountant’s request, Chopra asked Helio for these documents:
1. articles of incorporation,
2. minutes for meetings of the board of directors and shareholders
3. all financial statements,
4. all tax returns
10. monthly bank statements
11. company credit card statements
12. compensation records
13. the following contracts: life insurance policies for officers and/or stockholders; pension plan and
profit sharing plans; stock purchase plans; equipment and building leases; employment and bonus
agreements for owners or key employees; covenants not to compete; loan agreements and credit
Helio gave Chopra items 1-6 but refused to turn over the other materials. Chopra filed suit. The trial
court found for Helio and Chopra appealed.
You Be The Judge: Which of these documents must a company provide to its shareholders?
Holding: For Helio, the trial court’s ruling was affirmed. According to Chopra, the documents he
requested were necessary for assessing the value of Chopra’s investment in the company and determining
whether his interests as a minority shareholder were being protected. The records previously provided by
Helio were insufficient to make this determination.
According to the court, a shareholder has an interest in the assets and business of the company and
inspection of the company’s books may be necessary for the protection of his interest or for information
Chapter 20 Corporations 13
Question: What was Chopra’s role at Helio?
Answer: He was a minority shareholder and a former director of the company.
documents regarding bank loans, compensation records, insurance policies for officers, pension plans,
a list of patents, a key list of management personnel, an overview of the company’s objectives, and
information regarding lawsuits.
Question: Why was he not entitled to receive this information?
Answer: According to the court there were a number of reasons why Chopra was not entitled to this
information. First, the court did not believe he was making the request with a proper purpose. The
Question: Why is this wrong?
Answer: Although board members have a duty to shareholders to maximize shareholder value,
Right to Vote
A corporation must have at least one class of stock with voting rights.
Shareholder Meetings. Annual shareholder meetings are the norm for publicly traded companies.
Shareholder Proposals
Under SEC rules, any shareholder who has continuously owned for one year at least 1 percent of the
company or $2,000 of stock can require that one proposal be placed in the company’s proxy statement to
be voted on at the shareholder meeting.
The SEC traditionally recommended that shareholder proposals be in the form of non-binding requests
Question: Should shareholders be allowed to pass binding resolutions?
Answer:
Arguments in favor:
• Shareholders own the company. Why shouldn’t they be allowed to have some say?