CORPORATIONS

I. LIMITED LIABILITY

A. Cranson v. IBM p. 84-95: Appellee was granted summary judgment in the lower court on the theory that a defectively-formed corporation was neither a de jure nor a de facto corporation, and that appellant, as a partner, was personally liable for its debts, namely, the balance due on electric typewriters purchased by the corporation. After examining the doctrine of de facto corporations, the court reversed, holding that, even though one or more of the requisites of a de facto corporation were absent, application of the estoppel doctrine was not precluded. Neglect in defective formation could not be used by a corporation as a defense to an action to enforce its liabilities, and, since estoppel was based upon the inequity of permitting the denial of corporate existence by those dealing with it as such, appellee was estopped from denying the legality of that which was not even a corporation de facto. Judgment reversed because, although appellant lacked one of the requisite factors of a de facto corporation, appellee, who had dealt with the corporation as such, was estopped from denying its existence.

1. De Facto Corporation (See p. 85)

  • Existence of law authorizing incorporation
  • Good Faith Effort- to incorporate under the existing lawFailure to file papers all together is not good faith, would be if you left off seal or forgot to pay a fee.
  • Actual Use or exercise of Corporation Powerswould not occur if before a corporation began to operate there was a lawsuit of some sort to prohibit it’s incorporation (?)

2. Corporation by Estoppel – employed where the person seeking to hold the officer personally liable has contracted or otherwise dealt with the association in such a manner as to recognize and in effect admit its existence as a corporate body–

  • requires someone to treat you as if you were validly incorporated; correspondence or checks addressed to “incorporated”
  • Frequently invoked in contracts cases because outside party has capacity for self help
  • Almost never works in tort (in contrast to self-help)
  • Reflection of how cherished doctrine is for inspiring economic activity
  • Corporations inspire employment, higher levels of economic development
  • Corporations are often validly incorporated and they will be challenged

B. Piercing the Veil (i.e. circumstances when the courts will override their strong policy preference for limited liability)

1. Alter Ego or Instrumentality Rule – refer to the various situations that are an abuse of the corporate privilege;
If you treat a corporation as if it is your agent, your personal property, then the veil can be pierced

a. Corporation formalities: Whenever anyone uses control of the corporation to further his own rather than the corporation’s business, he will be liable for the corporation’s acts; If you had commingled corporate assets, a single number for cabs, used cabs for corporate and personal use

1) Waslkowsky p. 88-93: Plaintiff alleged that he was injured when a taxicab struck him. Defendant was stockholder of ten corporations, each of which had two cabs registered in its name and carried the minimum automobile insurance required by law. Although independent of one another, the corporations were alleged to have operated as a single enterprise. Plaintiff contended that he was entitled to hold defendant personally liable for his damages because the multiple corporate structure constituted an unlawful attempt to defraud members of the public. Defendant appealed the court's ruling that plaintiff had stated a cause of action. The court held that, whenever anyone used control of a corporation to further his own rather than the corporation's business, he would be liable for the corporation's acts under the principle of respondeat superior. However, the decision was reversed because plaintiff 's complaint failed to allege that defendant was doing business in his individual capacity.

b. Kinney Shoe at Handout 23-24 footnote: don’t treat the corporation with the dignity it deserves

  • Mere fact that you have a single shareholder does not qualify to pierce the corporate veil
  • Court do not like doing this, general presumption in favor of corporate-ness

2. Inadequate Capitalization: there are no minimum sums of dollars one needs to form a corporation; you will only pierce the veil for inadequate cap when the capital is trifling as compared to actual need of corporation

a. Minton p. 98-100: Defendant, the estate of a former director of a defunct corporation, appealed from a trial court judgment holding it personally liable for a wrongful death award against the corporation in a prior litigation. Defendant argued that decedent, an attorney, merely accepted director status to accommodate the defunct corporation, and the evidence did not support the determination that the "alter ego" doctrine was applicable. The court disagreed, holding that the trial court was not required to believe the statement that decedent was only a "temporary" director and officer "for accommodation." However, the court reversed the judgment on the grounds that decedent was not a party to the wrongful death action against the corporation, and the judgment in that action was therefore not binding upon him.

b. “The equitable owners of a corporation for example are personally liable when they treat the assets of the corporation as their own and add or withdraw capital from the corporation at will; when they hold themselves out as being personally liable for the debts of the corporation or when they provide inadequate capitalization and actively participate in the conduct of the corporate affairs.”

c. The evidence is undisputed that there was no attempt to provide adequate capitalization.

3. Fraud - puts out a statement claiming to have a certain amount in assets and does not

A corporate veil can be pierced either to reach:

  • An individual or individual shareholders
  • A parent corporation
  • “sibling” enterprises

II. CORPORATE PURPOSES

A. Dodge v. Fordp. 109 Defendant corporation's directors decided to exercise their discretion and hold back part of the company's capital earnings for reinvestment, thereby denying certain expected dividend payments to plaintiffs. Plaintiffs contended that the reason defendant corporation was holding back dividends, partially to reinvest in the company and bring down the ultimate cost of buying a car, was semi-humanitarian and was not authorized by the company's charter. The trial court held that defendant corporation was entitled to reinvest surplus capital gains at their discretion and did not order further dividends paid out. The appellate court reversed that decision and held that the accumulation of so large a surplus established that there was an arbitrary refusal to distribute funds to stockholders as dividends and ordered that such dividends, plus interest, should be paid by defendant corporation

  • When you have a corp incorp for profit and no language to the contrary in the certif. of incorp it must act primarily for the benefit of the shareholders, you can make contributions to the community but only tot eh extent that you can show a benefit to the shareholders

B. Smith v. Barlow at 115-120: Plaintiff company made a donation to PrincetonUniversity, and defendant stockholders sought a declaratory judgment to question the legality of plaintiff's donation. The lower court determined that plaintiff's donation was intra vires, and defendants sought review. On appeal, the court held that corporations were permitted to make contributions where the activity being promoted by the gift promoted the goodwill of the business of the corporation. Pursuant to N.J. Rev. Stat. § 14:3-13.1, et seq., corporations could make charitable donations provided that the contribution was not made to a donee institution that owned more than 10 percent of the voting stock of the donor and provided that the contribution had not exceeded one percent of capital and surplus, unless such donation was authorized by the stockholders. The court held that plaintiff's donation was valid. The court affirmed a judgment of the lower court.

  • Primarily for benefit of shareholders

Hypotheticals

1. Should a shareholder be permitted to enjoin a corporation from honoring a contract unenforceable under the statute of frauds?

2. An employee with 19 years experience is seriously hurt; his pension vests after 20 years. Could the corporation buy an annuity for him?

3. Corporation A hopes to gain a supply contract from Corporation B, a large firm. Profits will equal $5 million over two years. A vice president of Corporation B can guarantee that Corporation A will secure the contract for Corporation A if Corporation A will pay him $200,000. The risk of detection is small. Should Corporation A make this payment?

4. J Corporation runs a restaurant, the controlling interest in which is held by S. S. dies. The restaurant is inherited by T, who converts the restaurant to a strict vegetarian menu. Can a minority shareholder enjoin the menu change?

B. Charity – reasonable in amount

1. Indirect benefit

C. Unocal v. Revlon, Constituency Statutes at 124-125:

  • Unocal: The DL S.C. appeared to dramatically tilt the traditional notion of a corporation’s basic purpose when it reasoned that a board of directors could take into account, when analyzing the appropriateness of a tender offer defensive measure, its “impact on the ‘constituencies’ other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally”
  • Revlon: “A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders.”
  • maybe the purpose of the corporation isn’t just to the benefit of the shareholders, but also reaches out to other constituencies; half the states in the country have adopted constitutency statutes (mostly limited to takeover statutes) Constituency Statutes at 124-125

III. DUTY OF CARE

A. Basic Standard: basic negligence concept Directors and officers, their duties in good faith and with that degree of diligence, care and skill which ordinarily prudent person would exercise under similar circumstances in like positions

1. Bates v. Dresser p. 143-147: (Duty to supervise): Appellant bank president and directors and appellee bank receiver appealed the circuit court's judgment in favor of appellant directors but against appellant bank president on appellee's bill in equity charging appellants with the loss of the bank's assets though a bank employee's theft during their tenure. Although there were warning signs that the thieving employee was living the fast life and another employee raised the issue of possible theft, the theft was not ascertainable on the face of the bank's ledgers and semi-annual audits revealed no fraud. The Supreme Court affirmed the circuit court's entry of judgment in favor of appellant directors since there was no indication that they should have been on notice of the bank employee's theft; it also affirmed the judgment upholding appellant bank president's liability since he assumed responsibility for losses to the bank which were chargeable to his failure to act on the warning signs.

Note: obligation greater for full time President than for members of the board who are episodically there

  • Corporate boards of directors have a duty to supervise, not always demanding but when something puts them on notice they have a duty to inquire

a. One bite rule: If you have notice then you have a duty to take action (one bite rule), you have no duty to investigate until you are given notice that something is wrong.

2. Barnes v. Andrews p. 147-151: Plaintiff filed suit against defendant with respect to the latter's role as director of a corporation. The action centered upon general liability for the collapse of the enterprise; his specific liability for overpayments made to an individual, and his specific liability for the expenses of printing pamphlets and circulars used in selling the corporate shares. The court dismissed the suit, holding that there was no evidence that the defendant's neglect caused any losses to the company, and that, if there were, that loss could not be ascertained.

Note: business judgment rule NOT a defense to monitoring

a. Duty to perform with skill of person in like position (i.e. the D must be judged based on the duties of a director); duty to keep reasonably well informed, only occassionaly asked CEO how things were going

b. Causation: “The Plaintiff must accept the burden of showing that the performance of the defendan’ts duties would have avoided loss, and what loss it would have avoided”; reminded that this is a negligence claim, so must not only show a violation of the duty but also that the violation caused the damage (i.e. how much could have been saved by specific actions)

3. Francis v. United Jersey Bank p. 157-166: Defendants argued that the corporate directors whom defendants represented were not liable for fellow directors' conversion of trust funds because they were not aware of it. Plaintiffs argued that the directors were negligent in not noticing or trying to prevent the misappropriation, and that their negligence proximately caused the resulting harm. The court held that the directors did have a duty to exercise ordinary care in managing the corporation. The court noted that ordinary care included becoming familiar with corporate business, staying informed about activities, becoming familiar with corporate financial status, and objecting to or taking means to prevent illegal activity when it was discovered. The court then found that the directors had breached their duty by failing to do those things, and that such negligence proximately caused plaintiffs harm.

a. Basic Standard Amplified: “As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged. Because directors are bound to exercise ordinary care, they cannot set up as a defense lack of the knowledge needed to exercise the requisite degree of care.”

  • duty to habitually attend board meetings, to understand the rudiments of the business, to understand financial statements and to inquire when there is a mess

b. Proximate Cause Modified: “Determination of the liability of Mrs. Prtichard requires findings that she had a duty to the clients of Pritchard & Baird, that she breached that duty and that her breach was a proximate cause of their losses.”

  • more likely that P could establish standard; P only had to show that the D was a contributing factors; there was a significant contribution to the harm done to the contribution;
  • Mrs. Pritcher was bed ridden while the store robbed the store blind, but the fact that she didn’t’ read the financial statements was sufficient to hold that she was a proximate cause

4. Caremark Handout p. 28-31: The director’s duties include the duty to attempt in good faith to ensure that an adequate corporation information and reporting system operates.

  • The director’s duties include the duty to attempt in good faith to ensure that an adequate (compliance system )corporation information and reporting system operates;
  • board of directors responsibility to insure that your corporation is complying with laws and in good faith that this is being done

The derivative action alleged that members of the corporation's board of directors breached their fiduciary duty of care to the corporation in connection with alleged violations by the corporation's employees of federal and state laws and regulations applicable to health care providers. The suit purported to seek recovery of losses from individual defendants who constituted the board of directors of the corporation. The parties proposed that the suit be settled. The court stated that the record did not support the conclusion that defendants either lacked good faith in the exercise of their monitoring responsibilities or conscientiously permitted a known violation of law by the corporation to occur, and that the claims asserted against them had to be viewed as very weak. Despite the weakness of plaintiffs' claims, the court concluded that the proposed settlement appeared to be an adequate, reasonable, and had a beneficial outcome for all parties, and thus approved the settlement.

Note: Duty to maintain reporting and information system

B. Business Judgment Rule: When a corporate director or officer makes a business judgment in good faith, he or she will not be held liable for any losses that ensue as long as the director or officer is (1) not interest in the transaction, (2) is reasonably informed with respect to the subject of the business judgment, and (3) reasonably believes that the business judgment is in the best interest of the corporation.

1. Smith v. Van Gorkom p. 170-204: Plaintiffs argued that defendant directors' decision to approve a cash-out merger of their corporation into another violated Del. Code Ann. tit. 8, § 251, and did not warrant business judgment rule protection. The court agreed, finding that defendant directors based their decision on one person's representations, which did not constitute a report on which they could reasonably rely under Del. Code Ann. tit. 8, § 141(e), and that they did not seek documentation of either the merger terms or the adequacy of the proposed price per share. The court also found defendant directors were grossly negligent in permitting the agreement to be amended in a way they had not authorized. Finally, the court found that the stockholders' vote did not ratify the action, because the stockholders weren't aware of the lack of valuation information, and because defendant directors' statements were misleading.