Corporation Law Essay

QUESTION I

Ay, Bee, and Cee have come to see you. They have big plans and they want to make sure you can make it happen for them. They want to form a Delaware corporation for the purpose of buying Megastuff, Inc. also a Delaware Corporation. The corporation, to be called Alphabet, will be incorporated in Delaware. Megastuff in the business of buying odd lot consumer goods and selling them at a discount to consumers. They have no fixed inventory and sell what they can acquire from time to time.

Each of them will contribute $500,000 in exchange for shares. Ay wants to contribute the $500,000 in rural land located in Alaska that she has been unable to sell. Bee has $500,000 in cash, and Cee wants to contribute $250,000 in cash and give a note for the rest. Ay and Bee are interested in running the day to day business of Alphabet: Cee is not. But Cee is also worried that unless she has an effective veto on the board that Ay and Bee will run the new company into insolvency

All three want to share in the residual profits of the firm but Cee want to make sure that she gets the first $50,000 of funds distributed as dividends before dividends are paid to anyone else. She also wants to fully participate in residual dividends.

Ay, Bee, and Cee want to make sure they none of them would be able to sell their shares without the consent of the other shareholders. They also want to make sure that the board cannot terminate the employment of Ay as chief executive officer or Bee as chief operations officer. They also want to make sure that the new company never moves its corporate headquarters from the place they want to buy now and also that unanimous shareholder approval must be obtained before corporate funds are spent doing any kind of lobbying.

They have a list of questions for you. Please prepare a memo fully discussing with complete analysis, how they should approach decisions on each question:

1. How many shares should Alphabet issue? Should they all be common stock? What should be the price of the shares? Does it matter if Alphabet is authorized to issue more shares than they initially plan to sell to Ay, Bee and Cee?

2. Are there any issues with respect to the way in which the shareholders intend to pay for their shares? How should Cee's insistence on receiving $50,000 payments before other shareholders get dividend distributions be handled? Can Cee receive $50,000 before anyone else and still participate in any additional share distribution; and if so, how would that be structured?

3. Should the shares issued be par value or non-par value shares? How should they make that determination? If the shares are issued as par value shares, how should they determine the amount to set as par value? If no par stock is to be issued, how much should be designated as allocated to capital? Can they issue both par and no par shares at the same time? What would be the point of doing that? How long does the board have to make a decision about allocations of share prices to capital and surplus accounts? Does it make a difference if they issued par or no par stock? What difference if the RMBCA applied?

4. How can the shareholders ensure that each will be elected to the board? Please describe all of the methods that may be available, their risks, and advantages, and the steps necessary to comply with law. Can the shareholders ensure that the company is required to retain Ay and Bee as officers, that unanimous consent is required for allocation of funding for corporate governance, and that the company headquarters is never moved from the place that they intend to buy at the time corporate formation?

5. Assume that 5 years after Alphabet is organized and operating. Ay, who is now the Chief Executive Officer and President of Alphabet, without the knowledge or approval of the board, enters into a purchase agreement for a new headquarters building. The cost of the building will be about 15% of the company's annual net revenues. Ay has never done this before, but the sellers have often done business with Alphabet and specifically with Ay, sometimes with and sometimes without any direction by the board. Ay has a habit of getting the board to go along afterwards, but not always. Ay has entered into leases for property before without the board's approval for sums up to 10% of company's annual net revenue. Is the company bound by the agreement?

QUESTION 2

Assume a number of years have passed since Alphabet bought all the shares of and began operating Megastuff as its wholly owned subsidiary. Ay and Bee serve as the two board members of Megastuff to represent Alphabet as the sole shareholder. Alphabet's articles authorize the issuance of 1,000 shares of common stock and contain the following provision:

Whenever a vote of the shareholders is required by statute to approve an amendment to these Articles of Incorporation or a merger or sale of all or substantially all of the assets of the corporation, such approval shall be by the holders of two-thirds of the outstanding stock.

All 1.000 authorized shares have been issued. Ay and Bee each own 250 shares: Cee owns 350 shares. Fourteen other shareholders, mostly relatives of Ay and Bee, own the remaining 150 shares.

The Alphabet board consists of five directors: Ay (also president of the company), Bee (the chief financial officer), Cee, Dee (Cee's daughter), and Gee (Ay's sister in law).

Cee has been talking recently about acquiring more shares of Alphabet and Ay and Bee are concerned that if he buys the 150 shares from Ay and Bee's relatives (who are in financial difficulties) Cee might be in a position to control the company. They have told Cee that this is unacceptable to them and their relationships have become strained.

Part of the reason for the concern is that Cee also owns UltraStuff, Inc., a smaller firm that is in the same business as Megastuff. For the moment Ultra Stuff has an agreement with Megastuff by which each sells the others excess stack. But Ay understands that UltraStuff plans to open stores that would directly compete with Megastuff and both Ay ad Bee are concerned about that. Both now appear to be thinking about making bids on a piece of property in a new market area to open an additional store.

In the context of these expansion plans, Alphabet’s management has been concerned about a shortage of capital. They need fresh sources of cash to successfully initiate their expansion plans which they view as essential to the future profitability of the company. Moreover, within the last year Alphabet has experienced temporary shortages of cash. It has occasionally had to delay payments to suppliers, causing it to lose the usual trade discounts for prompt payment. A year ago, Alphabet’s bank rejected its request for a loan because the bank concluded Alphabet had already borrowed as much as was prudent and the bank doubted Alphabet’s ability to successfully manage future growth.

Ay, Bee and the other officers of the company have decided that the best course for Alphabet is to raise additional equity capital. At the last board meeting. Ay and Bee recommended an amendment to the articles of incorporation to double the number of authorized shares of common stock. Cee opposed the amendment, stating that Alphabet should not seek additional capital and that he would try to block the amendment. Though everyone on the board knew about Cee's ownership of UltraStuff, Cee fully participated in the meeting. He and Dee voted against the proposal but lost the vote because Ay. Bee and Gee voted in favor.

Ay has come to you seeking answers to the following questions:

1. What additional steps are required in order for Alphabet to adopt this amendment to its articles of incorporation?

2. Did Cee violate his fiduciary duty by his actions on the board? If so, then how? If you think he did, should he be liable to the shareholders or the company for that breach?

3. If Cee votes his stock against the proposed amendment, even though all the other directors believe in would benefit the corporation, could Alphabet successfully challenge Cee's action? Would it matter whether Cee was motivated by a good faith belief that it would not be in Alphabet’s best interest to sell more stock or simply by the desire to make it more difficult for Megastuff to compete with UltraStuff?

4. Assume that Alphabet’s shareholders defeated the proposal to change the articles of incorporation to increase the number of authorized shares. Ay, Bee and Gee, a majority of the Alphabet board, propose the following action:

A. That the board of Alphabet adopt a resolution approving the amendment to the Megastuff articles permitting it to double the mummer of shares Megastuff authorized to issue.

B. That Megastuff then sell those shares to investors for cash raising the funds necessary for meeting Megastuff's expansion plans.

C. That Ay, Bee, and Gee be granted to right to buy an additional 100 shares each in Megastuff for a deeply discounted price so that it will no longer be a wholly owned company.

The action was approved by the board by a vote of 3-2 with Cee and Dee voting against. Ay and Bee have asked you to answer the following questions. Assume that the transactions proposed by Ay, Bee and Gee do not need shareholder approval:

I. How likely is it that Cee would prevail on an action against Ay, Cee, and Gee for breach of fiduciary duty?

II. If Cee wanted to maintain a derivative action, is demand futile in this case?