Deck 32: Corporate Formation and Financing

Question 1

What circumstances in this case suggest that MB should be held liable for Bloom's fraud?

Answer 1

The following circumstances suggest that MB should be held liable for Bloom's fraud:
• Bloom operated the North hills the entire time that he was an executive of MB Investments Partners, Inc.
• Investments in North Hills were administered by Bloom and other MB personnel, using MB's offices, computers, filing facilities and other office equipment.
• MB support staff also carried out tasks related to North Hills.
• Mb officers and directors were aware that Bloom was operating North Hills while working at MB.
The above activities are performed by Bloom during his course of employment. Hence, as per the doctrine of imputation MB can be held liable.

Question 2

Ultra Vires Doctrine Oya Paka and two business associates formed a corporation called Paka Corp. for the purpose of selling computer services. Oya, who. owned 50 percent of the corporate shares, served as the corporation's president. Oya wished to obtain a personal loan from her bank for $250,000, but the bank required the note to be cosigned by a third party. Oya cosigned the note in the name of the corporation. Later, Oya defaulted on the note, and the bank sued the corporation for payment. The corporation asserted, as a defense, that Oya had exceeded her authority when she cosigned the note on behalf of the corporation. Had she? Explain.

Answer 2

Ultra Vires Doctrine:
In corporate law, acts of a corporation that are beyond its express or implied authority fall under the doctrine of ultra vires. In this case it could be argued that Oya exceeded her authority when she cosigned for a personal loan on behalf of the corporation so long as the act was not ordinary business of the corporation. Since the board did not ratify the loan, it was not sanctioned by the corporation.

Question 3

What conditions did the court place on the application of the imputation doctrine in this case?

Answer 3

According to the imputation doctrine, the corporation would be held liable if the fraud of an officer is associated with the corporation.
The conditions that are stated in imputation doctrine by the court is;
1. The fraud is done by an officer in the course of his employment.
2. Secondly the fraud is done for the benefit of the corporation.
The corporation is accountable for any acts committed by its agents with apparent authority of the corporation. Therefore the fraud conducted by the officer within his scope of authority can be obligated on the corporation.

Question 4

Spotlight on Smart Inventions-Piercing the Corporate Veil.

Thomas Persson and Jon Nokes founded Smart Inventions, Inc., to market household consumer products. The success of their first product, the Smart Mop, continued with later products, which were sold through infomercials and other means. Persson and Nokes were the firm's officers and equal shareholders. Persson was responsible for product development, and Nokes was in charge of day-to-day operations. By 1998, they had become dissatisfied with each other's efforts. Nokes represented the firm as financially "dying," "in a grim state,... worse than ever," and offered to buy all of Persson's shares for $1.6 million. Persson accepted. On the day that they signed the agreement to transfer the shares, Smart Inventions began marketing a new product-the Tap Light. It was an instant success, generating millions of dollars in revenues. In negotiating with Persson, Nokes had intentionally kept the Tap Light a secret. Persson sued Smart Inventions, asserting fraud and other claims. Under what principle might Smart Inventions be liable for Nokes's fraud? Is Smart Inventions liable in this case? Explain. [Persson v. Smart Inventions, Inc., 125 Cal.App.4th 1141, 23 Cal. Rptr.3d 335 (2 Dist. 2005)]

Question 5

MB, which was already in financial distress, had to cease operations as a result of Bloom's fraud. How might MB have discovered the fraud before it grew so large as to have such dire effects?

Question 6

Improper Incorporation Denise Rubenstein and Christopher Mayor agreed to form Bayshore Sunrise Corp. (BSC) in New York to rent certain premises and operate a laundromat. BSC entered into a twenty-year commercial lease with Bay Shore Property Trust on April 15,1999. Mayor signed the lease as the president of BSC. The next day-April 16-BSC's certificate of incorporation was filed with New York's secretary of state. Three years later, BSC defaulted on the lease, which resulted in its termination. Rubenstein and BSC filed a suit in a New York state court against Mayor, his brother-in-law Thomas Castellano, and Planet Laundry, Inc., claiming wrongful interference with a contractual relationship. The plaintiffs alleged that Mayor and Castellano conspired to squeeze Rubenstein out of BSC and arranged the default on the lease so that Mayor and Castellano could form and operate their own business, Planet Laundry, at the same address. The defendants argued that they could not be liable on the plaintiffs' claim because there had never been an enforceable lease-BSC lacked the capacity to enter into contracts on April 15. What theory might Rubenstein and BSC assert to refute this argument? Discuss. [ Rubenstein v. Mayor , 41 A.D.3d 826, 839 N.Y.S.2d 170 (2 Dept. 2007)]

Question 7

Piercing the Corporate Veil. Smith Services, Inc., a trucking business owned by Tony Smith, charged its fuel purchases to an account at Laker Express. When Smith Services was not paid on several contracts, it ceased doing business and was dissolved. Smith continued to provide trucking services, however, as a sole proprietor. Laker Express sought to recover Smith Services' unpaid fuel charges, which amounted to about $35,000, from Smith. He argued that he was not personally liable for a corporate debt. Should the court pierce the corporate veil? Explain. [Bear, Inc. v. Smith, 303 S.W.3d 137 (Ky.App. 2010)]

Question 8

Business Case Problem with Sample Answer: Close Corporations.

Mark Burnett and Kamran Pourgol were the only shareholders in a corporation that built and sold a house. When the buyers discovered that the house exceeded the amount of square footage allowed by the building permit, Pourgol agreed to renovate the house to conform to the permit. No work was done, however, and Burnett filed a suit against Pourgol. Burnett claimed that, without his knowledge, Pourgol had submitted incorrect plans to obtain the building permit, misrepresented the extent of the renovation, and failed to fix the house. Was Pourgol guilty of misconduct? If so, how might it have been avoided? Discuss. [Burnett v. Pourgol, 83 A.D.3d 756, 921 N.Y.S.2d 280 (2 Dept. 2011)]

Question 9

Piercing the Corporate Veil. In 1997, Leon Greenblatt, Andrew Jahelka, and Richard Nichols incorporated Loop Corp. with only $1,000 of capital. Three years later, Banco Panamericano, Inc., which was run entirely by Greenblatt and owned by a Greenblatt family trust, extended a large line of credit to Loop. Loop's subsidiaries then participated in the credit, giving $3 million to Loop while acquiring a security interest in Loop itself. Loop then opened an account with Wachovia Securities, LLC, to buy stock shares using credit provided by Wachovia. When the stock values plummeted, Loop owed Wachovia $1.89 million.
Loop also defaulted on its loan from Banco, but Banco agreed to lend Loop millions of dollars more. Rather than repay Wachovia with the influx of funds, Loop gave the funds to closely related entities and "compensated" Nichols and Jahelka without issuing any W-2 forms (forms reporting compensation to the Internal Revenue Service). The evidence also showed that Loop made loans to other related entities and shared office space, equipment, and telephone and fax numbers with related entities. Loop also moved employees among related entities, failed to file its tax returns on time (or sometimes at all), and failed to follow its own bylaws. In a lawsuit brought by Wachovia, can the court hold Greenblatt, Jahelka, and Nichols personally liable by piercing the corporate veil? Why or why not? [Wachovia Securities, LLC v. Banco Panamericano, Inc., 674 F.3d 743 (9th Cir. 2012)]

Question 10

A QUESTION OF ETHICS: Improper Incorporation.
Mike Lyons incorporated Lyons Concrete, Inc., in Montana, but did not file its first annual report, so the state involuntarily dissolved the firm in 1996. Unaware of the dissolution, Lyons continued to do business as Lyons Concrete. In 2003, he signed a written contract with William Weimar to form and pour a certain amount of concrete on Weimar's property in Lake County for $19,810. Weimar was in a rush to complete the entire project, and he and Lyons orally agreed to additional work on a time-and-materials basis. When scheduling conflicts arose, Weimar had his own employees set some of the forms, which proved deficient. Weimar also directed Lyons to pour concrete in the rain, which undercut its quality. In mid-project, Lyons submitted an invoice for $14,389, which Weimar paid. After the work was complete, Lyons sent Weimar an invoice for $25,731, but he refused to pay, claiming that the $14,389 covered everything. To recover the unpaid amount, Lyons filed a mechanics lien as "Mike Lyons d/b/a Lyons Concrete, Inc." against Weimar's property. Weimar filed a suit in a Montana state court, to strike the lien, and Lyons filed a counterclaim to reassert it. [ Weimar v. Lyons, 338 Mont. 242,164 P.3d 922 (2007)]
?
(a) Before the trial, Weimar asked for a change of venue on the ground that a sign on the courthouse lawn advertised "Lyons Concrete." How might the sign affect a trial on the parties' d?spute? Should the court grant this request?
(b) Weimar asked the court to dismiss the counterclaim on the ground that the state had dissolved Lyons Concrete in 1996. Lyons immediately filed new articles of incorporation for "Lyons Concrete,
Inc." Under what doctrine might the court rule that Weimar could not deny the existence of Lyons Concrete? What ethical values underlie this doctrine? Should the court make this ruling?
(c) At the trial, Weimar argued, in part, that there was no "fixed price" contract between the parties and that even if there were, the poor quality of the work, which required repairs, amounted to a breach, excusing Weimar's further performance. Should the court rule in Weimar's favor on this basis?

Question 11

Corporate versus LLC Form of Business. Although a limited liability company (LLC-see Chapter 38) may be the best organizational form for most businesses, a significant number of firms may be better off as a corporation or some other form of organization.
?
(a) The first group will outline several reasons why a firm might be better off as a corporation than as an LLC.
(b) The second group will discuss the differences between corporations and LLCs in terms of their management structure.

Question 12

Incorporation. Jonathan, Gary, and Ricardo are active members of a partnership called Swim City. The partnership manufactures, sells, and installs outdoor swimming pools in the states of Arkansas and Texas. The partners want to continue to be active in management and to expand the business into other states as well. They are also concerned about rather large recent judgments entered against swimming pool companies throughout the United States. Based on these facts only, discuss whether the partnership should incorporate.

Question 13

What is the imputation doctrine? What public-policy reasons support imputing the fraud of a corporate officer to the corporation?

Question 14

William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia. Sharp maintained a corporate checking account but paid the club's employees, suppliers, and entertainers in cash out of the club's proceeds. Sharp owned the property on which the club was located. He rented it to the club but made mortgage payments out of the club's proceeds and often paid other personal expenses with Chickasaw corporate funds.
At 12:45 a.m. on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club. A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley's identification to verify her age. Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 a.m. with a beer in her hand. Shortly afterward, Pursley lost control of her car, struck a tree, and was killed. Joseph Dancause, Pursley's stepfather, filed a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages. Using the information presented in the chapter, answer the following questions.
1. Under what theory might the court in this case make an exception to the limited liability of shareholders and hold Sharp personally liable for the damages? What factors would be relevant to the court's decision?
2. Suppose that Chickasaw's articles of incorporation failed to describe the corporation's purpose or management structure as required by state law. Would the court be likely to rule that Sharp is personally liable to Dancause on that basis? Why or why not?
3. Suppose that the club extended credit to its regular patrons in an effort to maintain a loyal clientele, although neither the articles of incorporation nor the corporate bylaws authorized this practice. Would the corporation likely have the power to engage in this activity? Explain.
4. How would the court classify the Chickasaw Club corporation-domestic or foreign, public or private? Why?

Question 15

QUESTION WITH SAMPLE ANSWER: Preincorporation.
Cummings, Okawa, and Taft are recent college graduates who want to form a corporation to manufacture and sell personal computers. Peterson tells them he will set in motion the formation of their corporation. First, Peterson makes a contract with Owens for the purchase of a piece of land for $20,000. Owens does not know of the prospective corporate formation at the time the contract is signed. Second, Peterson makes a contract with Babcock to build a small plant on the property being purchased. Babcock's contract is conditional on the corporation's formation. Peterson secures all necessary subscription agreements and capitalization, and he files the articles of incorporation.
?
(a) Discuss whether the newly formed corporation, Peterson, or both are liable on the contracts with Owens and Babcock.
(b) Discuss whether the corporation is automatically liable to Babcock on formation.