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?
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Question 1
The value of each share must be determined before the number of shares Alphabet should have is determined. The value of the Corporation is reflected in the price per share. With a total investment of $1,500,000, I propose the Alphabet issue 1,500,000 shares at $1 each. As a result, the startup is worth $1.5 million. It is generally important that the stock price represents the company's true worth. When most businesses start out, they are priced at about $1, but their worth will quickly increase. If Alphabet's stock price rises significantly and Ay and Cee are unable to pay for the shares in full, the owners will be individually responsible to pay the remaining share price at the company's request. For example, if a corporation is unable to pay its debts and owes money to suppliers. As a result, each co-founder would have the same number of shares (500, 000).
Common stock may be a sort of insurance that represents a company's ownership. The board of directors is elected by the stockholders and have a say in corporate policies. This manner of equity ownership typically yields higher rates of return over time (Fama and French, 2021). Common shareholders, on the opposite hand, do not have access to a company's assets until bondholders, debt holders, and preferred shareholders are fully compensated. The stockholder's equity portion of a company's record is where common shares is registered (Schanzenbach and Sitkoff, 2020). Common stockholders are not compensated until creditors, bondholders, and preferred shareholders have received their shares when a corporation with ordinary shares declares bankruptcy.
The primary distinction between preferred and customary stock is that preference shares lacks voting rights. Preferred shareholders do not have any influence within the company's future when it involves selecting a board of directors or agreeing on corporate policies. stock is comparable to bonds therein it pays a guaranteed dividend for the remainder of the investor's life (Fama and French, 2021). Therefore, since Ay, Bee and Cee should consider having ordinary shares since they need to possess total control of the corporate and voting rights. The dividend yield on stock is calculated by dividing the dividend amount by the present stock price. A preferred stock's value is usually calculated before it is sold (Fama and French, 2021). According to Fama and French (2021), it is normally calculated as a percentage of the present market value after it begins trading. Unlike ordinary shares, which pays variable payments that are never assured by the management board, preferred shares pay fixed dividends.
Many companies do not pay common stockholders’ dividends. As per Cieslak and Pang (2020), preference shares, including bonds, have values that are laid low with interest rates. If interest rates rise, the worth of preferred shares falls, and the other way around. In the other hand, the demand and supply of market participants determine the value of common stocks. In the event of a liquidation, preferred stockholders have a greater claim to the company's properties and earnings (Cieslak and Pang, 2020). The identical is true when the corporation is doing well and has excess cash to allocate to investors within the type of dividends (Fama and French, 2021). This stock's dividends are usually more than those paid on common shares. That if a company fails to pay a dividend, it must first pay any arrears to preferred shareholders before paying common shareholders, and that preference shares have priority over ordinary shares.
Stocks, unlike ordinary shares, have a callability feature that allows the issuer to redeem the shares from the market after a certain time has passed. Shareholder who obtain preference shares run the danger of getting their shares called back at a far higher pace than their initial investment (Cieslak and Pang, 2020). within the preferred share market, callbacks are often anticipated, and costs is bid up accordingly (Fama and French, 2021). Ordinary shares have the advantage of outperforming bonds and preferred shares to time.
Many companies issue all three types of securities (Cieslak and Pang, 2020). Most of the requirements that the co-founders list require voting rights, and hence I would advise Ay, Bee, and Cee to issue all shares as common stock. The co-founders want to make sure 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 a 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. Unanimous shareholder approval must be obtained before corporate funds are spent doing any lobbying. All these issues will be solved with voting rights which comes with common stock.
It does matter if Alphabet is given permission to sell more shares to Ay, Bee, and Cee than they originally planned. The number of shares that Alphabet Corporation will issue is technically stated in the articles of incorporation. According to Cieslak and Pang (2020), if the Corporation wishes to issue more shares than that amount permits, they must file an amendment to their articles of incorporation, for which most states charge a small fee.
Question 2
Since Ay has land worth $500,000 that she has been unable to sell and Cee needs to pay $250,000 later, they will have to pay the company $750,000 and notify the US stock exchange that their shares have been partially charged. A partially paid share indicates that other shareholders have paid a portion of the issue price in advance. For each share priced at $1, this means that $0.50 has been charged instead of $1. The remaining balance will be paid at a later date.
The insistence of Cee to receive $50,000 is possible, and she can continue to participate in any additional share distribution. The law requires corporations to distribute dividends equitably, in proportion to the number of shares owned by each shareholder. For example, if the Corporation distributes dividends amongst three shareholders who own equal shares at 33.3% of the company, the shareholders would be entitled to equal amounts. Cee insisting on getting $50,000 would mean Ay and Bee need to receive the same amount. A total of $150,000 is required. However, since she is the only one insisting on getting the money, the situation can be structured so that Ay and Bee do not want to receive dividends at that particular time while the other shareholder receives a dividend payment.
In the example above, if both Ay and Bee shareholders waived their right to a dividend, the other shareholder, Cee, would receive $50,000. In this situation, the parties must remember that all dividend waivers must be made for commercial purposes in order to prevent a tax appeal. They cannot be used on a daily basis, and the dividend waiver must be formally executed and signed by all investors or other individuals entitled to the shares.
An alternative approach is to have different classes of shares. After declaring dividends, the shareholders need to declare them as income, whether received or not, to all holders of a class of shares. If Cee wants to take dividends and Ay and Bee do not, the Company's Articles need to be amended by Special Resolution to split the Ordinary shares into A and B Ordinary shares, which rank side by side in all respects except dividends. Then, the existing shares need to be reassigned to the new A and B classes of shares. The Corporation can then declare a dividend on one class but not on the other so that A, for example, to which Cee belongs, receives dividend while group B ordinary shares, to which Ay and Bee belong, do not. The shareholders' agreement should be so that those who did not get dividends do not lose out.
Question 3
The Alphabet co-founders should issue par shares, in my opinion. Shares with no par value on the front of the stock certificate are known as non-par value stocks. The price at which a cooperative's shares were first traded was known as par value (Weiman and James, 2020). If the selling price falls below the par value, the disparity between the sale price and the par value is considered a potential loss to the company's shareholders.
To escape potential liability, companies set the par value as low as possible. Determining the par value involves knowing the lowest currency unit, $0.01, which is often used as the par value (Milman, 2018). Some states permit businesses to issue shares with no par value, essentially removing the issuer's theoretical obligation to shareholders. As a result, state laws are the first and most important determinant of how Alphabet will issue its shares. When a company's common stock has no par value, any stock certificates it issues would state "no par value" (Milman, 2018). The details can also be contained in the articles of incorporation of the issuer.
When a corporation's stock has no par value, the price is determined by the amount that customers are willing to pay based on their assessment of the issuing entity's worth (Milman, 2018). The value can be found on several factors: cash flows, market competitiveness, and technological changes (Milman, 2018). The cash gaine...