Business associations

              c)Apparent Authority ‑‑ a.k.a. "ostensible authority"--apparent authority is the power to affect the legal relationships of another person by transactions with third persons, professedly as agent for the other, arising from and in accordance with the other's manifestations to such third persons." Rest §8. But note that the manifestation includes allowing the agent to represent accurately his own authority.

              d)Inherent Authority--this is the authority that inheres in an office. General agent (agent authorized to conduct a series of transactions involving continuity of service): P is bound if A is acting in the interests of P and A does an act usual or necessary with respect to the authorized transactions ;

                 1)Unusual activities--depositing corporate checks on a personal account is an unusual activity, and the bank should make inquiry if the person is authorized to do that; otherwise, the bank is liable to the principal for lost money (Mohr)

              e)Ratification--ratification is the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him." Rest § 82. The principal can affirm by words, or by deeds. This includes the failure to repudiate the subject matter when presented, suing to enforce the obligation, retaining the benefits of the transaction. Note several things:

                 1)Ratification assumes that the principal was not previously bound. If the principal had been previously bound, then the liability would be based on another agency theory.

                 2)It doesn't matter to whom the affirmance is made. It could be to the agent, to the third party, or anyone else or nobody at all. Why? Because what was lacking in the original contract was merely his expression of assent to the relationship of agency. The terms are fixed, the third party believes he has an agreement, all that's missing is the opposite party. So the President of the firm's note to himself that the affirms may be sufficient. If there are some formalities required to authorize an act ‑‑e.g., sealed instruments, deeds ‑‑ then there might be additional formality required for affirmance.

              f)Estoppel--purported principal either (a) intentionally or carelessly causes the belief that a purported agent is acting on his behalf, or (b) sits silently knowing that such belief exists without taking reasonable steps, and the third party relies detrimentally.

     C.ULTRA VIRES TRANSACTIONS--those beyond the purposes and powers, express and implied, of the corporation. Under common law, shareholder ratification of an ultra vires transaction nullified the use of an ultra vires defense by the corporation.

          1.TORT ACTIONS--ultra vires is NO defense to tort liability.

          2.CRIMINAL ACTIONS--claims that a corporate act was beyond the corp’s authorized powers are NO defense to criminal liability.

          3.CONTRACT ACTIONS--at common law, a purely executory ultra vires contracts were NOT enforceable against either party; fully performed contracts could NOT be rescinded by either party; and, under the majority rule, partially performed contracts were generally enforceable by the performing party, since the nonperforming party was estopped to assert an ultra vires defense.

          4.STATUTES--most states now have statutes that preclude the use of ultra vires as a defense in a suit between the contracting parties, but permit ultra vires to be raised in certain other contexts:

              a)Suits Against Officers or Directors--if performance of an ultra vires contract results in a loss to the corp, it can sue the officers or dirs for damages for exceeding their authority.

              b)Suit By State--these limiting statutes do NOT bar the state from suing to enjoin a corp from transacting unauthorized business.

              c)Broad Certificate Provisions--when the certificate of incorporation states that the purpose is to engage in any lawful activity for which corp may be organized, ultra vires is unlikely to arise.

V.MANAGEMENT AND CONTROL

     A.ALLOCATION OF POWERS BETWEEN DIRECTORS AND SHAREHOLDERS

          1.MANAGEMENT OF CORPORATION’S BUSINESS--corporate statutes vest the power to manage in the board of directors, except as provided by valid agreement in a close corp. He board’s power is limited to proper purposes.

          2.SHAREHOLDER APPROVAL OF FUNDAMENTAL CHANGES--shs must approve certain fundamental changes in the corp, e.g., amendment of articles, merger, sale of substantially all assets, and dissolution.

          3.POWER TO ELECT DIRECTORS--shs have the power to elect dirs and to remove them for cause, absent provisions for removal without cause in the certificate, bylaws, or in statutes. Some statutes also permit the board or the courts to remove a dir for certain specific reasons (e.g., felony conviction).

          4.POWER TO RATIFY MANAGEMENT TRANSACTIONS--shs have the power to ratify certain management transactions and insulate the transactions against a claim that managers lacked authority, or shift the burden on the issue of self-interest.

          5.POWER TO ADOPT PRECATORY RESOLUTIONS--shs may also adopt advisory but nonbinding (precatory) resolutions on proper subjects of their concern.

          6.BYLAWS--shs usually have the power to adopt and amend bylaws, although some statutes give the board of dirs the concurrent power to do this.

          7.CLOSE CORPORATION--this is a corp owned by a small number of shs who may actively manage; it has no general market for its stock, and it has some limitations regarding transferability of stock.

          8.STATUTORY CLOSE CORPORATION STATUS--the basic requirements to qualify for special treatment under the statutes are that, in its cert of incorp’n, a statutory close corp must identify itself as such, and must include certain limitations as to the number of shs, transferability of shares, or both.

              a)Functioning As a Close Corporation--there may be sh agreements relating to any phase of the corp affairs.

               

     B.DIRECTORS

          1.APPOINTMENT OF DIRECTORS--initial dirs are either designated in the articles of incorporation or elected at a meeting of incorporators. Subsequent elections are by shs at their annual meetings. The number of dirs is usually set by the articles or bylaws.

              a)Qualifications--absent a contrary provision in the articles or bylaws, dirs need not be shs of the corp or residents of the state of incorporation.

              b)Vacancies--statutes vary, but under Model Act, a vacancy may be filled by either the shs or dirs.

                 1)Compare--removal: some statutes require that vacancies created by removal of a dir be filled by the shs unless the articles or bylaws provide otherwise.

          2.TENURE OF OFFICE

              a)Term of Appointment--under most statutes, office is held until the next meeting, although on a classified board, dirs may serve staggered multi year terms.

              b)Power to Bind Corporation Beyond Term--unless limited by the articles, the board has the power to make contracts biding the corp beyond the dirs’ term of office.

              c)Removal of Director During Term--at common law, shs can remove a dir for cause (e.g., fraud, incompetence, dishonesty) unless an article or bylaw provision permits removal without cause. a dir being removed for cause is entitled to a hearing by shs before a vote to remove. a number of statutes permit removal without cause.

                 1)Removal by Board--board can NEVER remove a dir unless authorized by statute;

                 2)Removal by Court--there is a split authority as to whether a court can remove a dir for cause.

                     I)Statutes--some statutes permit courts to remove a dir for specified reasons. Usually, a petition for removal can be brought only by a certain percentage of shs or the attorney general.

          3.FUNCTIONING OF BOARD

              a)Meetings--absent a statute, dirs can act only at a duly convened meeting consisting of a quorum. In most jurisdictions, a meeting can be conducted by telephone or other means whereby participants can hear each other simultaneously. Most statutes also allow board action by unanimous written consent without a meeting.

                 1)Notice--although formal notice is unnecessary for a regular meeting, special meetings require notice to every dir of date, time, and place. Usually, notice can be waived in writing before or after a meeting. Attendance waives notice unless the dir attends only to protest the meeting.

                 2)Quorum--a majority of the authorized number of dirs constitutes a quorum. Many statutes permit the articles or bylaws to require more than simple majority or less than that.

                 3)Voting--absent a contrary provision, an affirmative vote of a majority of those present, not a majority of those voting, is required for board action.

              b)Effect of Noncompliance With Formalities--today, most courts hold that informal but unanimous approval of a transaction is effective, as is a matter receiving the explicit approval by a majority of dirs without a meeting, plus acquiescence by the remaining dirs.

              c)Delegation of Authority--the board has the power to appoint committees of its own members to act for it either in particular matters or to handle day-to-day management between board meetings. Typically, these committees cannot amend the articles or bylaws, adopt or recommend major corporate changes (e.g., merger), recommend dissolution, declare a dividend, or authorize issuance of stock unless permitted by the articles or bylaws. Note that while the board may delegate operation of the business to an officer or management company, the ultimate control must be retained by the board.

              d)Provisional Directors--some statutes allow them to be appointed by court if the board is deadlocked and corporate business is endangered. a provisional dir serves until the deadlock is broken or until removed by a court order or by majority of shs.

              e)Voting Agreements--an agreement in advance among dirs as to how they will vote is void as contrary to public policy. There are certain exceptions for statutory close corps.

          4.COMPENSATION--dirs are NOT entitled to compensation unless they render extraordinary services or such compensation is otherwise provided for. Officers are entitled to reasonable compensation for services.

          5.DIRECTORS’ RIGHTS, DUTIES, AND LIABILITIES

              a)Right to Inspect Corporate Records--if done in good faith for purposes germane to his position as dir, this right is absolute.

              b)Duty of Care--dirs must exercise the care of an ordinarily prudent and diligent person in a like position, under similar circumstances. There is no liability (absent a conflict of interest, bad faith, illegality, or gross negligence) for errors of judgment (business judgment rule--the rebuttable presumption that action was taken on an informed basis, in good faith and exercising reasonable care), but the dir must have been reasonably diligent before the rule can be invoked (Shlensky)

                 1)The duty of care requires:

                     I)Education--a dir should acquire at least a rudimentary understanding of the business of the corporation;

                     ii)Information--a dir is under a continuing obligation to keep informed about the activities of the corp;

                     iii)Participation--dirs must “generally monitor” corporate affairs, but need NOT involve themselves in the day-to-day operations; (i.e. they should attend board of dirs meetings with reasonable regularity).

                     iiii)Inquiry--a dir has a duty to inquire when circumstances would alert a reasonable person for the need of inquiry.

                     iiiii)Action--where wrongdoing is revealed, a dir should object, correct, or resign. Object to the course of conduct, steer toward correction, and resign if it isn’t corrected.

                 2)Extent of liability--dirs are personally liable for corporate losses directly resulting from their breach of duty or negligence in falling to discover wrongdoing. a director may seek to avoid being held personally liable for acts of the board by recording his dissent.

                     I)Many statutes permit the articles to abolish or limit dir’s liability for breach of the duty of care absent bad faith, intentional misconduct, or knowing violation of law.

                 3)Defenses to liability--these include good faith reliance on management or expert’s reports. Disabilities may be considered in determining whether the dir has met the standard of care.

              c)Duty of Loyalty--a catch-all duty designed to prevent unfairness--the duty to act in good faith (BJR applies). Application:

                 1)Self-dealing transactions

                     I)Common Law:

                        (1)early absolute prohibition against self-dealing renders transactions void or                                      voidable;

                        (2)permissive self-dealing: dirs and officers may contract with the corp if (a)done                        in “strictest good faith.”; (b)with full disclosure; and (c)consent of “all concerned.”

                             [1]--burden of proof is on the dir to establish good faith, honesty & fairness;

                             [2]--courts weigh self-dealing transactions with “closest scrutiny”

                        (3)self-dealing prohibition also applies to intercorporate transactions where dirs                                  are common.

                     ii)Statutory (example):

                        (1)quasi-safe harbor approach (Iowa statute)--transaction is not void or voidable                                  because of dirs’ interest, if either:

                             [1]--interest is disclosed and approval is made without counting the vote of the                                      interested dir.

                             [2]--interest is disclosed to shs and shs authorize

                             [3]--transaction is fair and reasonable

                        (2)Note--dir must still establish that he acted in good faith, honesty, and fairness

                 2)Domination of subsidiary by parent--courts look at the transaction to see if self-dealing has occurred. Example (Sinclair Oil):

                     I)declaration of dividends shared pro rata was NOT self-dealing; BJR applies

                     ii)contract between parent and sub was self-dealing; apply intrinsic fairness test

                 3)Manager’s compensation:

                     I)Ordinary corporations--conflicts are inevitable but all firms need to set compensation. The burden of proof is placed on challengers as a matter of convenience.

                     ii)Close corporations--the income generated by the firm may be diverted to salaries, so there is an option for self-dealing by the parties in control to take tax-advantaged compensation in the form of salaries (taxed once) as opposed to dividends (taxed twice).

                   

              d)Statutory Duties and Liabilities--in addition to general duty of care, federal and state laws also impose certain duties and liabilities, e.g., registration requirements under the Securities Act of 1933, liability for rule 10b-5 violations, liability for illegal dividends. Some statutes also impose criminal liability on corporate managers for unlawful corporate actions.

     C.OFFICERS

          1.ELECTION--officers are usually elected by the board of dirs. Some statutes permit election of officers by shs.

          2.AUTHORITY OF CORPORATE OFFICERS (liability of corp to outsiders)--only authorized officers can bind the corp. Authority may be: actual (expressed in bylaws or by valid board resolution), apparent (corp gives third parties reason to believe authority exists), or power of position (inherent to position). If ratified by the board, even unauthorized acts can bind the corp.

              a)Authority of President--the majority rule is that the president has the power to bind the corp in transactions arising in regular course of business.

     

          3.DUTIES OF CORPORATE OFFICERS--the duty of care owed by a officer is similar to that owed by dirs ( and sometimes higher).

     D.CONFLICTS OF INTEREST IN CORPORATE TRANSACTIONS.

          1.DUTY OF LOYALTY--because of their fiduciary relationship with the corp, officers and dirs have the duty to promote the interests of the corp without regard for personal gain.

          2.BUSINESS DEALINGS WITH THE CORPORATION--conflict of interest issues arise when a corp transacts business with one of its officers or dirs, or with a company in which an officer or dir is financially interested.

              a)Effect of Self-Interest on Right to Participate in Meeting--most statutes permit an “interested” dir to be counted toward quorum, and interested dir’s transactions are NOT automatically voidable by the corp because the interested dir’s vote was necessary for approval.

              b)Voidability Because of Director’s Self-Interest--today, such transactions are voidable only if unfair to the corporation. The burden of establishing fairness is on the interested director. Note that a dir’s failure to fully disclose material facts may be per se unfair.

                 1)Unanimous shareholder ratification--if, after full disclosure, shareholder ratification is unanimous, the corp will be estopped from challenging the transaction with the interested dir (except at to creditors).

                     I)Less-than-unanimous ratification--courts then will look at whether the majority shares were owned or controlled by the interested director. Courts are more likely to uphold ratification by a disinterested majority so as to preclude the transaction from being attacked by the corp or by a sh in a derivative suit.

                 2)Statutes--most statutes provide that such transactions are NOT voidable if: (1)approved, after full disclosure, by a disinterested board majority or by majority of shs, or (2)the transaction is fair to the corp notwithstanding disclosure.

                     I)”Interested”--an “interested” dir or officer is one who has a business, financial, or familial relationship with a party to the transaction that would reasonably affect the person’s judgment so as to adversely affect the corp.

              c)Remedies--the corp may rescind, or affirm and sue for damages.

          3.INTERLOCKING DIRECTORATES--generally, transactions between corps with common dirs are subject to the same rules of interested director transactions. There is no conflict of interest if one corp is the wholly owned subsidiary of the other. However, a question of fairness arises where the parent owns only a majority of the subsidiary’s shares.

          4.CORPORATE OPPORTUNITY DOCTRINE (Also see duty of loyalty)

              a)Definition--COD bars dirs from taking any business opportunity belonging to the corp without first offering it to the corp.. If the corp is unwilling to pursue an opportunity (after an independent board is fully informed of the opportunity), then the dir may pursue it.

              b)Defenses (available in most, but not all jurisdictions):

                 1)Inability--If the corp is legally or financially unable to take the opportunity, then the dir generally may take advantage of it. (But the question of who caused the financial inability is quite relevant. Example: Irving Trust Co--the defense of inability was rejected).

                 2)Rejection, abandonment, or approval--then the fiduciary has a valid defense.

              c)Remedies--constructive trust or damages--the fiduciary must account to the firm for all the profits he has made as a result of usurpation.

              d)Definition of a Corporate Opportunity:

                 1)Line of business test--does the firm have fundamental knowledge, practical experience, and ability to pursue the opportunity? If yes, then it is within the firm’s line of business. It should be a natural fit, and not a mere desire by a firm to pursue the opportunity.

                 2)Interest/expectancy test

              e)Application--Guth Rule and Corollary:

                 1)Guth rule (offered in corporate capacity)--if there is presented to O/D a business opportunity which the corp is (1)financially able to undertake, which is from its nature (2a) in the line of business and is of practical advantage to it OR (2b)is one in which the corp has an interest or reasonable expectancy (under an established corporate policy or plan), and, (3)by embracing the opportunity the self-interest of the dir will be brought into conflict with that of his corp, then officer or dir may NOT take the opportunity.

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