2 Cases - BUS LAW - Brief Case

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BACKGROUND AND FACTS • In 2001, W. P. Media, Inc., and Alabama MBA, Inc., agreed to form a joint venture—to be called Alabaster Wireless MBA, LLC—to provide wireless Internet services to consumers. W. P. Media was to create a wireless network and provide ongoing technical support. Alabama MBA was to contribute capital of $79,300, and W. P. Media was to contribute “proprietary technology” in the same amount. Hugh Brown signed the parties’ contract on Alabama MBA’s behalf as the chair of its board. At the time, however, Alabama MBA’s articles of incorporation had not yet been filed. Brown filed the articles of incorporation in 2002. Later, Brown and Alabama MBA filed a suit in an Alabama state court, alleging that W. P. Media had breached their contract by not building the wireless network. The court issued a summary judgment in the defendant’s favor. The plaintiffs appealed.

IN THE LANGUAGE OF THE COURT

SMITH, Justice. **** Corporate action may * * * be established under principles of estoppel,

whether or not an entity or organization qualifies as a de facto corporation. The doctrine is based on conduct by a party that recognizes an organization as a corporation or an express or implied representation by a corporation that it is a corporation. In the first instance, estoppel cannot apply to one who has not dealt with the organization or in any way recognized it as having corporate existence, or who has participated in holding it out as a corporation. In the second instance, where a party has contracted or otherwise dealt with an organization, believing it to be a corporation, there may have been no holding out of corporate status by the organization. In either instance, estoppel arises from the contract or course of dealing by the parties and is applicable in a suit by the party dealing with the organization, as well as in a suit by the organiza- tion. [Emphasis added.]

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Alabama MBA * * * argues that because W. P. Media treated Alabama MBA as a corporation, W. P. Media is now estopped from denying Alabama MBA’s corporate existence.

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W. P. Media entered into a contractual relationship with Alabama MBA to operate Alabaster Wireless. The operating agreement identified Alabama MBA as a corporation, was executed in Alabama MBA’s corporate name, and was signed by Brown as Alabama MBA’s “chairman of the board.” W. P. Media further concedes * * * that Alabama MBA and Brown had essentially “represented” that Alabama MBA was “a viable, legal corporation” and that W. P. Media had “no reason to doubt” those representations. Although Alabama MBA had not yet filed articles of incorporation at the time the operating agreement was executed in 2001, the articles of incorporation were subsequently filed in 2002. * * * At no time during the venture did W. P. Media challenge the validity of the operating agreement until after it was sued for breaching the operating agreement. Under the facts of this case, we hold that W. P. Media’s actions of entering into a contract with Alabama MBA and participating with Alabama MBA in the joint venture before and after Alabama MBA’s articles of incorporation were filed estop W. P. Media from denying Alabama MBA’s corporate existence for purposes of challenging the validity of the operating agreement.

DECISION AND REMEDY • The Alabama Supreme Court reversed the lower court’s judg- ment and remanded the case. Under the principle of corporation by estoppel, W. P. Media could not deny Alabama MBA’s corporate existence.

THE LEGAL ENVIRONMENT DIMENSION • Did Alabama MBA exist as a de facto corporation when it entered into the contract with W. P. Media? Why or why not?

WHAT IF THE FACTS WERE DIFFERENT? • Would the result in this case have been different if the parties’ contract to build and operate a wireless network had been negotiated and agreed to entirely online? Discuss.

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frequently provide default rules that apply if the company’s bylaws are silent on an issue, it is impor- tant that the bylaws set forth the specific operating rules of the corporation. In addition, after the bylaws are adopted, the corporation’s board of directors will pass resolutions that also grant or restrict corporate powers.

The following order of priority is used if a con- flict arises among the various documents involving a corporation:

1. The U.S. Constitution.

2. State constitutions.

3. State statutes.

4. The articles of incorporation.

5. Bylaws.

6. Resolutions of the board of directors.

Implied Powers

Certain implied powers arise when a corporation is created. Unless expressly prohibited by a consti- tution, a statute, or the articles of incorporation, the corporation has the implied power to perform all acts reasonably appropriate and necessary to accomplish its corporate purposes. For this reason, a

CORPORATE POWERS

Under modern law, a corporation generally can engage in any act and enter into any contract avail- able to a natural person in order to accomplish the purposes for which it was formed. When a corpo- ration is created, the express and implied powers necessary to achieve its purpose also come into existence.

Express Powers

The express powers of a corporation are found in its articles of incorporation, in the law of the state of incorporation, and in the state and federal con- stitutions. State statutes often give corporations a wide variety of powers, allowing a corporation to issue stocks and bonds, execute contracts and negotiable instruments, buy and sell (or lease) prop- erty, pay employee benefits, and make charitable contributions.

Corporate bylaws and the resolutions of the cor- poration’s board of directors also grant or restrict certain powers. Because state corporation statutes

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corporation has the implied power to borrow funds within certain limits, lend funds, and extend credit to those with whom it has a legal or contractual relationship.

To borrow funds, the corporation acts through its board of directors to authorize the loan. Most often, the president or chief executive officer of the corporation will execute the necessary papers on behalf of the corporation. Corporate officers such as these have the implied power to bind the corpora- tion in matters directly connected with the ordinary business affairs of the enterprise. There is a limit to what a corporate officer can do, though. A corpo- rate officer does not have the authority to bind the corporation to an action that will greatly affect the corporate purpose or undertaking, such as the sale of substantial corporate assets.

Ultra Vires Doctrine

The term ultra vires means “beyond the power.” In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts. Under Section 3.04 of the RMBCA, shareholders can seek an injunction from a court to prevent the corporation from engaging in ultra vires acts. The attorney general in the state of incorporation can also bring an action to obtain an injunction against ultra vires transactions or to institute dissolution proceedings against the cor- poration on the basis of ultra vires acts. The corpora- tion or its shareholders (on behalf of the corporation) can seek damages from the officers and directors who were responsible for the ultra vires acts.

In the past, most cases dealing with ultra vires acts involved contracts made for unauthorized pur- poses. Now, however, most private corporations are organized for “any legal business” and do not state a specific purpose, so the ultra vires doctrine has declined in importance in recent years. Today, cases that allege ultra vires acts usually involve nonprofit corporations or municipal (public) corporations.

CASE IN POINT Four men formed a nonprofit cor- poration to create the Armenian Genocide Museum & Memorial (AGM&M). The bylaws appointed them as trustees (similar to corporate directors) for life. One of the trustees, Gerard L. Cafesjian, became the chair and president of AGM&M. Eventually, the relationship among the trustees deteriorated, and Cafesjian resigned. The corporation then brought a suit claiming that Cafesjian had engaged in numer- ous ultra vires acts, self-dealing, and mismanagement. Among other things, although the bylaws required an 80 percent affirmative vote of the trustees to take

action, Cafesjian had taken many actions without the board’s approval. He had also entered into con- tracts for real estate transactions in which he had a personal interest. Because Cafesjian had taken actions that exceeded his authority and had failed to follow the rules set forth in the bylaws for board meetings, the court ruled that the corporation could go forward with its suit.9

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PIERCING THE CORPORATE VEIL

Occasionally, the owners use a corporate entity to perpetrate a fraud, circumvent the law, or in some other way accomplish an illegitimate objective. In these situations, the courts will ignore the corporate structure and pierce the corporate veil, exposing the shareholders to personal liability [RMBCA 2.04].

Generally, when the corporate privilege is abused for personal benefit, the courts will require the own- ers to assume personal liability to creditors for the corporation’s debts. The courts will also impose per- sonal liability when the corporate business is treated so carelessly that the corporation and the controlling shareholders are no longer separate entities. In short, when the facts show that great injustice would result from the use of a corporation to avoid individual responsibility, a court will look behind the corporate structure to the individual shareholders.

Factors That Lead Courts to Pierce the Corporate Veil

The following are some of the factors that frequently cause the courts to pierce the corporate veil:

1. A party is tricked or misled into dealing with the corporation rather than the individual.

2. The corporation is set up never to make a profit or always to be insolvent, or it is too “thinly” cap- italized—that is, it has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities.

3. The corporation is formed to evade an existing legal obligation.

4. Statutory corporate formalities, such as holding required corporation meetings, are not followed.

5. Personal and corporate interests are mixed  together, or commingled, to the extent that the corporation has no separate identity.

9. Armenian Assembly of America, Inc. v. Cafesjian, 692 F.Supp.2d 20 (D.C. 2010).

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Although state corporation codes usually do not pro- hibit a shareholder from lending funds to her or his cor- poration, courts will scrutinize the transaction closely if the loan comes from an officer, director, or majority shareholder. Loans from persons who control the cor- poration must be made in good faith and for fair value.

A Potential Problem for Closely Held Corporations

The potential for corporate assets to be used for per- sonal benefit is especially great in a closely held cor- poration, in which the shares are held by a single

person or by only a few individuals, usually fam- ily members. In such a situation, the separate sta- tus of the corporate entity and the sole shareholder (or family-member shareholders) must be carefully preserved. Certain practices invite trouble for the one-person or family-owned corporation: the com- mingling of corporate and personal funds, the failure to hold board of directors’ meetings and record the minutes, and the shareholders’ continuous personal use of corporate property (for example, vehicles).

In the following case, a creditor asked the court to pierce the corporate veil and hold the sole shareholder-owner of the debtor corporation per- sonally liable for a corporate debt.