Quiz 28: Corporate Formation, Merger, and Termination

What steps are involved in bringing a corporation into existence? Who is liable for preincorporation contracts?

Corporate Status. Three brothers inherited a small paper-supply business from their father, who had operated the business as a sole proprietorship. The brothers decided to incorporate under the name of Gomez Corp. and retained an attorney to draw up the necessary documents. The attorney drew up the papers and had the brothers sign them but neglected to file the articles of incorporation with the secretary of state's office. The brothers assumed that all necessary legal work had been completed, so they proceeded to do business as Gomez Corp. One day, a Gomez Corp. employee, while making a delivery to one of Gomez's customers, negligently ran a red light and caused an accident. Baxter, the driver of the other vehicle, was injured as a result and sued Gomez Corp. for damages. Baxter then learned that no state authorization had ever been issued to Gomez. Corp., so he sued each of the brothers personally for damages. Can the brother avoid personal liability for the tort of their employee? Explain.

Corporate Formation, Merger, and Termination In November 2002, Mario Bonsetti and Rico Sanchez incorporated Gnarly Vulcan Gear, Inc. (GVG), to manufacture windsurfing equipment. Bonsetti owned 60 percent and Sanchez owned 40 percent of the corporation's stock, and both men served on the board of directors. In January 2005, Hula Boards, Inc., owned solely by Mai Jin Li, made a public offer to Bonsetti and Sanchez to buy GVG stock Hula offered 30 percent more than the market price per share for the GVG stock, and Bonsetti and Sanchez each sold 20 percent of their stock to Hula. Jin Li became the third member of the GVG board of directors. In April 2007, an irreconcilable dispute arose between Bonsetti and Sanchez over design modifications of their popular Baked Chameleon board. Despite Bonsetti's dissent, Sanchez and Jin Li voted to merge GVG with Hula Boards under the latter name. Gnarly Vulcan Gear was dissolved, and production of the Baked Chameleon ceased. Using the information presented in the chapter, answer the following questions. 1. What rights does Bonsetti have (n most states) as a minority shareholder dissenting to the merger of GVG and Hula Boards? 2. Could the parties have used a short-form merger procedure in this situation? Why or why not? 3. What is the term used for Hula's offer to purchase GVG stock? 4. Suppose that after the merger, a person who was injured on the Baked Chameleon board sued Hula (the surviving corporation). Can Hula be held liable for the injury? Why or why not?

The following multiple-choice question is representative of the types of questions available in one of the four sections of ill ThomsonNOW for Business Law Today. ThomsonNOW also provides feedback for each response option, whether correct or incorrect, and refers to the location within the chapter where the correct answer can be found. In corporate law, when a corporation acts beyond the scope of its authority, it is said to A) engage in respondent superior. B) pierce the corporate veil. C) hide the corporate veil. D) engage in ultra vires transactions.

What is the difference between a de jure corporation and a de facto corporation?

Shareholders' Duties. Milena Weintraub and Larry Griffith were shareholders in Grand Casino, Inc., which operated a casino in South Dakota. Griffith owned 51 percent of the stock and Weintraub 49 percent. Weintraub managed the casino, which Griffith typically visited once a week. At the end of 2012, an accounting audit showed that the cash on hand was less than the amount posted in the casino's books. Later, more shortfalls were discovered. In October 2014, Griffith did a complete audit. Weintraub was unable to account for $200,500 in missing cash. Griffith then kept all of the casino's most recent profits, including Weintraub's $90,447.20 share, and, without telling Weintraub, sold the casino for $400,000 and kept all of the proceeds. Weintraub filed a suit against Griffith, asserting a breach of fiduciary duty. Griffith countered with evidence of Weintraub's misappropriation of corporate cash. (See page 796.) (a) The first group will discuss the duties that these parties owed to each other, and determine whether Weintraub or Griffith, or both, breached those duties. (b) The second group will decide how this dispute should be resolved and who should pay what to whom to reconcile the finances. (c) A third group will discuss whether Weintraub or Griffin violated any ethical duties to each other or to the corporation.

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text. In what circumstances might a court disregard the corporate entity ("pierce the corporate veil") and hold the shareholders personally liable?

Question with Sample Answer-Corporate Powers. Kora Nayenga and two business associates formed a cor­poration called Nayenga Corp. for the purpose of selling com­puter services. Kora, who owned 50 percent of the corporate shares, served as the corporation's president. Kora wished to obtain a personal loan from his bank for $250,000, but the bank required the note to be cosigned by a third party. Kora cosigned the note in the name of the corporation. Later, Kora defaulted on the note, and the bank sued the corporation for payment. The corporation asserted, as a defense, that Kora had exceeded his authority when he cosigned the note. Had he? Explain.

What are the four steps of the merger or consolidation procedure?

Torts and Criminal Acts. Greg Allen is an employee, a share-holder, a director, and the president of Greg Allen Construction Co. In 1996, Daniel and Sondra Estelle hired Allen's firm to renovate a home they owned in Ladoga, Indiana. TO finance the cost, they obtained a line of credit from Banc One, Indiana, which required periodic inspections to disburse funds. Allen was on the job every day and super-vised all of the work. He designed all of the structural changes, including a floor system for the bedroom over the living room, the floor system of the living room, and the stairway to the second floor. He did all of the electrical, plumbing, and carpentry work and installed all of the windows. He did most of the dry-wall taping and finishing and most of the painting. The Estelles found much of this work to be unacceptable, and the bank's inspector agreed that it was of poor quality. When Allen failed to act on the Estelles' complaints, they filed a suit in an Indiana state court against Allen Construction and Allen personally, alleging, in part, that his individual work on the project was negligent Can both Allen and his corporation be held liable for this tort? Explain. [Greg Allen Construction Co. v. Estelle, 798 N.E.2d 171 (Ind. 2003)]

What are the two ways in which a corporation can be voluntarily dissolved? Under what circumstances might a corporation be involuntarily dissolved by state action?

Purchase of Assets. Paradise Pools, Inc. (PPI), also known as "Paradise Pools and Spas," was incorporated in 1981. In 1994, PPI entered into a contract with Bromanco, Inc., to build a pool in Vicksburg, Mississippi, as part of a Days Inn Hotel project being developed by Amerihost Development, Inc. PPI built the pool, but Bromanco, the general contrac-tor, defaulted on other parts of the project, so Arnerihost completed the construction itself. Litigation ensued in Mississippi state courts, and Arnerihost was awarded $12,656.46 against PPI. Meanwhile, Paradise Corp. (PC) was incorporated in 1995 with the same management as PPI, but different shareholders. PC acquired PPI's assets in 1996, without assuming its liabilities, and soon became known as "Paradise Pools and Spas." Amerihost obtained a writ of garnishment against PC to enforce the judgment against PPI. PC filed a motion to dismiss the writ on the basis that it was "not a party to the proceeding." Should the court dismiss the case? Why or why not? [Paradise Corp. v. Amerihost Development, Inc., 848 So.2d 177 (Miss. 2003)]

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. Persson and Nokes were the firm's officers and equal shareholders, with Persson responsible for product development and Nokes in charge of day-to-day activities. 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)]

Corporate Powers. InterBel Telephone Co-operative, Inc., is a Montana corporation organized tinder the Montana Rural Electric and Telephone Cooperative Act. This statute limits the purposes of such corporations to providing "adequate telephone service," but adds that this "enumeration... shall not be deemed to exclude like or similar objects, purposes, powers, mariners, methods, or things." Mooseweb Corp. is an Internet service provider that has been owned and operated by Fred Weber since 1996. Mooseweb pro-vides Web site hosting, modems, computer installation, technical support, and dial-up access to customers in Lincoln County, Montana. InterBel began to offer Internet service in 1999, competing with Mooseweb in Lincoln County. Weber filed a suit in a Montana state court against InterBel, alleging that its Internet service was ultra vires. Both parties filed motions for summary judgment. In whose favor should the court rule, and why? [Weber v. InterBel Telephone Co-operative, Inc., 2003 MT 320, 318 Mont. 295, 80 P.3d 88 (2003)]

Purchase of Assets. In January 1999, General Star Indemnity Co. agreed to insure Indianapolis Racing League (IRL) racecars against damage during on-track accidents. In connection with the insurance, General Star deposited $400,000 with G Force LLC (GFCO), a Colorado firm, to enable it to buy and provide, without delay, parts for dam-aged cars. GFCO agreed to return any unspent funds. Near the end of the season, Elan Motorsports Technologies (EMT) acquired GFCO. In 2000, EMT incorporated G Force LLC in Georgia (CFGA), and GFCO ceased to exist. GFCA renewed the arrangement with General Star and engaged in the same operations as GFCO, but EMT' employees conducted CFGA's business at EMT's offices. In 200Z, EMT assumed ownership of GFGA's assets and continued the business. EMT also assumed GEGA's liabilities, except for the obligation to return General Star's unspent funds. General Star filed a suit in a Georgia state court against EMT, seeking to recover its deposit. What is the rule concerning the liability of a corporation that buys the assets of another? Are there exceptions? Which principles apply in this case? Explain. [General Star Indemnity Co. v. Elan Motorsports Techno: ogles, Inc., 356 F.Supp.2d 1333 (N.D.Ga. 2004)]

Dissolution. Clara Mahaffey operated Mahaffey's Auto Salvage, Inc., in Dayton, Ohio, as a sole proprietorship. In 1993, Kenneth Stumpff and Mahaffey's son, Richard Harris, joined the firm. Stumpff ran the wrecker and bought the vehicles for salvage. Harris handled the day-to-day operations and the bookkeeping. They became the company's equal 50 percent shareholders on Mahaffey's death in 2002. Harris, who inherited the land on which the firm was located, increased the rent to $1,500 per month. Within two years of Mahaffey's death, and without consulting Stumpff, Harris raised the rent to $2,500. Stumpff's wife died, and he took a leave of absence, during which the company paid him $2,500 a month and provided health insurance. After two years, Harris stopped the payments, discontinued the health benefits, and fired Stumpff, threatening to call the police if he came on the premises. Stumpff withdrew $16,000 from the firm's account, leaving a balance of $113. Harris offered to buy Stumpff's interest in the business, but Stumpff refused and filed a suit in an Ohio state court against Harris. A state statute permits the dissolution of a corporation if the owners are deadlocked in its management. Should the court order the dissolution of Mahaffey's? Why or why not? [Stumpff v. Harris, 2006 WL 2640232 (Ohio App. 2006)] (See page 809.)

A Question of Ethics. In 1990, American Design Properties, Inc. (ADP), leased premises at 8604 Olive Boulevard in St. Louis County, Missouri. Under the lease agreement, ADP had the right to terminate the lease on 120 days' written notice, but it did not have the right to sublease the premises without the lessor's (landowner's) consent. ADP had no bank account, no employees, and no finds. ADP had never filed an income tax return or held a directors' or share-holders' meeting. In fact, ADP's only business was to collect and pay the exact amount of rent due under the lease. American Design Group, Inc. (ADG), a wholesale distributor of jewelry and other merchandise, actually occupied 8604 Olive Boulevard. I. H. Blum owned ADG and was an officer and director of both ADC and ADP. Blum's husband, Marvin, was an officer of ADC and signed the lease as an officer of ADP. Marvin's former son-in-law, Matthew Smith, bras a salaried employee of ADC, an officer of ADC, and an officer and director of ADP. In 1995, Nusrala Four, Inc. (later known as Real Estate Investors Four, Inc.), purchased the property at S604 Olive Boulevard and became the lessor. No one told Nusrala that ADC was the occupant of the premises leased by ADP. ADP continued to pay the rent until November 1998, when Smith paid with a check drawn on ADC's account. No more payments were made. On February 26, 1999, Marvin sent Nusrala a note that read, "We have vacated the property at 8604 Olive," which, Nusrala discovered, had been damaged. Nusrala filed a suit in a Missouri state court against ADG and ADP, seeking compensation for the damage. In view of these facts, consider the following questions. (Real Estate Investors Four, Inc. v. American Design Group, Inc., 46 S.VV.3d 51 (Mo.App. E.D. 2001) 1. Given that ADO had not signed the lease and was not rightfully a sublessee, could ADO be held liable, at least in part, for the damage to the premises? Under what theory might the court ignore the separate corporate identities of ADG and ADP? If you were the judge, how would you rule in this case? 2. Assuming that ADP had few, if any, corporate assets, would it be fair to preclude Nusrala from recovering compensation for the damage from ADC? 3. Is it ever appropriate for a court to ignore the corporate structure? Why or why not?

Critical Legal Thinking. What are some of the ways in which the limited liability of corporate shareholders serves the public interest? Are there any ways in which this limited liability is harmful to the public interest? Explain.

Video Question. Go to this text's Web site at www.thomsonedu.com/westbuslaw/bft and select "Chapter 28." Click on "Video Questions" and view the video titled Corporation or LLC- Which Is Better? Then answer the following questions. 1. Compare the liability that Anna and Caleb would be exposed to as shareholders/owners Ma corporation versus as members of a limited liability company (LLC). 2. How does the taxation of corporations differ from that of LLCs? 3. Given that Anna and Caleb conduct their business (Wizard Internet) over the Internet, can you think of any drawbacks to forming an LLC? 4. If you were in the position of Anna and Caleb, would you choose to create a corporation or an LLC? Why?