- In a corporation, the board of directors has the authority to declare dividends. Under which of the following circumstances may dividends be declared?
Answer: Dividends may be declared only when the corporation has sufficient surplus or, under some statutes, sufficient funds from which dividends may lawfully be paid, and only if the dividend would not render the corporation insolvent.
Under corporate law (both the Model Business Corporation Act and Delaware law), dividends may be declared by the board of directors only from legally available funds - generally surplus (assets minus liabilities minus stated capital) or, under the MBCA's insolvency test, as long as the dividend does not render the corporation unable to pay its debts as they come due or leave assets less than liabilities plus preferential liquidation rights. Dividends may not be paid from capital and may not be declared if the corporation is insolvent. Answer A is incorrect because dividends cannot be declared if the corporation is insolvent. Answer C is incorrect because shareholders generally approve extraordinary matters but do not vote on dividend declarations (the board decides). Answer D imposes a restriction not found in corporate law.
- A limited partner participates extensively in the management and control of a limited partnership. Under traditional limited partnership law, what is the consequence?
Answer: The limited partner may lose limited liability protection and be treated as a general partner with unlimited personal liability, at least to third parties who reasonably believed the limited partner was a general partner.
Under traditional limited partnership law (ULPA 1976), a limited partner who participates in the control of the business may lose limited liability protection. Third parties who reasonably believed the limited partner was a general partner based on their control activities may hold the limited partner personally liable. The Revised Uniform Limited Partnership Act (RULPA 2001) significantly reduced this control rule, but under traditional law (and many state versions), control participation can result in general partner-like liability. Answer A is incorrect because profit rights are not affected. Answer C is incorrect because control participation does not automatically remove a partner. Answer D is incorrect under traditional limited partnership law.
- Piercing the corporate veil allows courts to hold shareholders personally liable for corporate debts. Which of the following is a factor courts consider when deciding whether to pierce the corporate veil?
Answer: Commingling of corporate and personal funds, failure to observe corporate formalities, undercapitalization, and use of the corporate form to perpetrate fraud.
Courts pierce the corporate veil to hold shareholders personally liable when the corporate form is being abused. Common factors include: commingling of personal and corporate assets, failure to observe corporate formalities (regular meetings, separate records, etc.), inadequate capitalization at formation, and use of the corporate form to commit fraud or avoid legal obligations. Answer B is incorrect because profitability is not a veil-piercing factor. Answer C is incorrect because shareholder count is not relevant to veil-piercing analysis. Answer D is incorrect because a shareholder's vote against an action does not protect them from veil-piercing.
- In a general partnership, a partner's act binds the partnership in a contract with a third party. Under RUPA, which of the following describes when a partner has the authority to bind the partnership?
Answer: When the partner is acting within the ordinary course of the partnership's business (apparent authority) or when the partner has actual authority from the partners.
Under RUPA Section 301, each partner is an agent of the partnership for purposes of its business. An act by a partner for carrying on in the ordinary course of the partnership's business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the third party had notice of the restriction. Partners also bind the partnership when acting with actual authority. Answer A is incorrect because unanimous consent is not required for ordinary business acts. Answer B is incorrect because ratification may work but is not the only basis for binding authority. Answer C is incorrect because written authorization from a managing partner is not required for ordinary business acts.
- In a limited liability company (LLC), what protection does the limited liability shield provide to members?
Answer: Members are generally not personally liable for the LLC's debts and obligations; their personal assets are protected from the LLC's creditors, similar to shareholders of a corporation.
The LLC structure provides members with limited liability protection: members are generally not personally liable for the LLC's debts, obligations, or liabilities solely by reason of being a member. This protection is analogous to the corporate shield for shareholders. The LLC's debts are obligations of the entity only. Answer B is incorrect because the LLC liability shield fully protects members' personal assets, not merely up to their capital contribution - though their investment in the LLC may be at risk. Answer C is incorrect because the shield covers both contract and tort liabilities. Answer D is incorrect because personal guarantees are a separate matter; absent a guarantee, the general rule is full protection without the capital-contribution limit.
- Under the Revised Uniform Partnership Act (RUPA), what is the default rule for sharing profits and losses in a general partnership?
Answer: Profits and losses are shared equally among all partners, regardless of capital contribution, absent a contrary agreement.
Under RUPA Section 401(b), partners share profits equally and losses in the same proportion as profits, absent a contrary agreement. If three partners contribute different amounts of capital, they still share profits and losses equally (one-third each) unless their partnership agreement specifies otherwise. Answer A is incorrect because under the default rule, losses are also shared equally (in the same proportion as profits, which is equal). Answer B describes an alternative arrangement that requires an express agreement. Answer D incorrectly applies limited partnership concepts to a general partnership.
- Under partnership law, the term 'winding up' refers to which of the following?
Answer: The process of completing unfinished partnership business, paying off creditors, liquidating assets, and distributing remaining proceeds to partners after the partnership has been dissolved.
Winding up is the final phase of a partnership's existence following dissolution. During winding up, the partnership (typically through the partners or a liquidating partner) completes existing contracts, collects amounts owed, converts assets to cash, pays creditors (including partner-creditors), and distributes any remaining proceeds to partners in accordance with their interests. Answer A describes admission of new partners, not winding up. Answer B describes refinancing, which is an operational activity. Answer D describes a transfer to a successor, which may occur but is not the definition of winding up.
- An S corporation has one class of stock. A shareholder receives a distribution of $60,000 when their stock basis is $10,000. How is this distribution treated?
Answer: The first $10,000 reduces basis to zero with no gain; the remaining $50,000 is treated as gain from the sale or exchange of stock (capital gain if held for more than one year).
S corporation distributions are tax-free to the extent of the shareholder's stock basis. The first $10,000 of the $60,000 distribution reduces the stock basis from $10,000 to zero with no income recognized. The remaining $50,000 exceeds the basis and is treated as gain from the sale or exchange of the S corporation stock under Section 1368. If the stock was held for more than one year, the gain is long-term capital gain. Answer A is incorrect because distributions are not ordinary income if they are within basis. Answer C is incorrect because the excess over basis is taxable. Answer D is incorrect because S corporation distributions are not dividends subject to the qualified dividend rules.
- An S corporation shareholder who owns 50% of the S corporation's stock receives a $30,000 cash distribution. The shareholder's stock basis before the distribution is $45,000. What is the shareholder's stock basis after the distribution?
Answer: $15,000, because the distribution reduces basis dollar-for-dollar.
S corporation cash distributions reduce the shareholder's stock basis dollar-for-dollar (after first increasing basis for the shareholder's allocable share of income for the year). No gain is recognized as long as the distribution does not exceed the shareholder's stock basis. Distribution of $30,000 from basis of $45,000 = remaining basis of $15,000. No gain is recognized because the distribution did not exceed the basis. Answer A is incorrect in the remaining basis calculation. Answer B is incorrect because the distribution ($30,000) does not exceed the basis ($45,000), so no gain is recognized. Answer D is incorrect because distributions do reduce stock basis.
- Under corporate law, preemptive rights give shareholders which of the following protections?
Answer: The right to purchase a proportional share of any new stock issuance before it is offered to the public, preserving their percentage ownership interest.
Preemptive rights give existing shareholders the right to purchase a proportionate share of any new stock issuance before the shares are offered to outside investors, allowing shareholders to maintain their percentage ownership and avoid dilution. Under the MBCA, preemptive rights must be expressly granted in the articles of incorporation; they do not exist by default. Answer B describes a put option or redemption right, not a preemptive right. Answer C describes liquidation preferences, which relate to preferred stock liquidation priority, not preemptive rights. Answer D describes voting rights, which are separate from preemptive rights.
- The business judgment rule protects corporate directors from personal liability for business decisions. Under the business judgment rule, which of the following conditions must be met for the protection to apply?
Answer: The director must have made an informed decision in good faith, in the honest belief that the action is in the corporation's best interests, and without a disqualifying conflict of interest.
The business judgment rule creates a presumption that directors act on an informed basis, in good faith, and in the honest belief that the action is in the corporation's best interests. Courts will not second-guess a business decision that was: (1) made in good faith, (2) with adequate information, and (3) without a disqualifying conflict of interest. The rule does not require profitable outcomes. Answer A is incorrect because the rule applies regardless of whether the decision was profitable. Answer B is incorrect because outside legal counsel consultation is not required. Answer C is incorrect because the rule can apply to decisions made in various capacities, not only formal board votes.
- Under the priority of distribution rules when a partnership winds up, in what order are the partnership's assets distributed?
Answer: Creditors (other than partners who are creditors) are paid first, then partners who are creditors for loans made to the partnership, then partners receive their capital contributions and remaining profits.
Under RUPA Section 807, upon winding up a partnership's business, assets are applied in the following order: (1) payment of outside creditors (non-partner creditors); (2) payment of partner-creditors for amounts owed other than capital and profits; and (3) distribution to partners for their capital and profits. This creditor-first priority protects outside creditors from having partnership assets depleted by distributions to partners before their claims are satisfied. Answer A puts capital ahead of creditors, which is incorrect. Answer B (equal distribution) ignores the creditor-first priority. Answer C puts profit shares before creditors, which is incorrect.
- Under corporate law, which of the following correctly describes the fiduciary duties owed by a corporate director to the corporation and its shareholders?
Answer: Directors owe a duty of care (to act with the care of a reasonably prudent person in a similar position) and a duty of loyalty (to act in the best interests of the corporation and avoid self-dealing).
Corporate directors owe two principal fiduciary duties: (1) the duty of care, requiring directors to act with the care that a reasonably prudent person in a similar position would exercise under similar circumstances; and (2) the duty of loyalty, requiring directors to act in the best interests of the corporation and its shareholders, avoiding conflicts of interest and self-dealing. Both duties are owed to the corporation and, by extension, to all shareholders including minorities. Answer A omits the duty of loyalty. Answer C incorrectly limits the duty of loyalty to creditors. Answer D is incorrect because fiduciary duties run to all shareholders, not only the majority.
- Under the RUPA, when a partner dissociates from a partnership, what happens to the partnership by default?
Answer: Under RUPA, dissociation does not automatically cause dissolution; the partnership may continue its business, and the dissociating partner is entitled to be bought out at the value of their interest.
The RUPA significantly changed the rules compared to the original UPA. Under RUPA, a partner's dissociation does not automatically dissolve the partnership. The remaining partners may continue the business, and the dissociating partner has the right to have their interest purchased at the buyout price (generally the greater of the going concern value or the liquidation value). Dissolution under RUPA requires additional events such as willful dissolution by all partners, court order, or occurrence of an event specified in the partnership agreement. Answer A describes the old UPA rule, not the RUPA rule. Answer B invents a 30-day cash payment requirement. Answer C invents a 90-day voting requirement.
- In an LLC, which of the following correctly describes the default management structure in a member-managed LLC?
Answer: All members have the right to participate in management, and each member acts as an agent of the LLC for carrying on its ordinary business.
In a member-managed LLC (the default structure under most state LLC statutes), all members have the right to participate in management and each member is an agent of the LLC with authority to bind it in ordinary business transactions. This is analogous to a general partnership structure. In a manager-managed LLC, management is delegated to one or more designated managers, and non-manager members have no management authority. Answer B is incorrect because management authority is not allocated by ownership percentage by default. Answer C is incorrect because members do have management rights in a member-managed LLC. Answer D describes a proportional voting rule that requires an express agreement.
- Shareholders of a closely held corporation have which of the following special rights compared to publicly held corporations, if provided for in a shareholder agreement?
Answer: Shareholders may restrict transfers of shares through rights of first refusal or buy-sell provisions, require cumulative voting, and, in some states, directly manage the corporation rather than through a board of directors.
Close corporations have significant flexibility to arrange governance differently from public corporations. Common provisions in close corporation shareholder agreements include: buy-sell agreements with rights of first refusal (restricting transfer of shares), cumulative voting rights (giving minority shareholders representation on the board), and in many states, elimination of the board of directors in favor of direct shareholder management. Answer A is incorrect because a shareholder agreement cannot override the board's discretion over dividends absent specific provisions. Answer C is incorrect because inspection rights are qualified and do not allow unlimited access. Answer D is incorrect because minority veto rights must be specifically negotiated; they are not a default right.
- In a general partnership, each partner has unlimited personal liability for the partnership's debts. Which of the following correctly describes the liability of a newly admitted partner for debts incurred before they joined?
Answer: The new partner is liable for pre-existing partnership debts only to the extent of their investment in the partnership; their personal assets are not at risk for pre-existing debts.
Under RUPA Section 306(b), a person admitted as a partner into an existing partnership is not personally liable for partnership obligations incurred before the person's admission. The new partner's liability for pre-existing debts is limited to their capital contribution or investment in the partnership - creditors with pre-existing claims cannot reach the new partner's personal assets for those debts. However, the new partner is fully personally liable for debts incurred after joining. Answer A overstates the new partner's liability for pre-existing debts. Answer B adds a knowledge requirement not in the statute. Answer C invents a 50% cap not found in the law.
- In an LLC, what is the default rule regarding a member's right to transfer their membership interest to a third party?
Answer: A member may freely transfer their economic interest (right to distributions) but may not transfer governance rights (voting and management) without the consent of the other members.
Under most state LLC statutes (following the Revised Uniform LLC Act), a member may freely assign their economic interest (distributions and allocations) to a third party, but the assignee does not automatically become a full member with governance rights (voting, management participation). For the assignee to become a full member, the consent of the existing members is required. This protects members from having unwanted co-members in what is often a close, personal business relationship. Answer A is incorrect because governance rights cannot be freely transferred. Answer C is incorrect because economic interests may be freely transferred. Answer D incorrectly requires a majority vote even for the transfer of economic interests.
- In a limited partnership, what is the general partner's personal liability for the partnership's debts?
Answer: The general partner has unlimited personal liability for all debts and obligations of the partnership.
In a limited partnership, the general partner bears unlimited personal liability for all the partnership's debts and obligations, just as a general partner in a general partnership. The limited partners' liability is limited to their capital contributions, but the general partner(s) remain personally liable. This unlimited liability is a fundamental characteristic of general partnership status. Answer A is correct. Answer B describes the liability of a limited partner, not the general partner. Answer C is incorrect because entity status does not shield the general partner from personal liability in a limited partnership. Answer D is incorrect because general partner liability is not limited by timing.
- In a general partnership, what is the default rule regarding management rights among partners?
Answer: Each partner has an equal right to participate in management and control of the partnership, regardless of the size of their capital contribution, absent a contrary agreement.
Under the Revised Uniform Partnership Act (RUPA) and its predecessors, the default rule is that each partner has an equal right to participate in the management and conduct of the partnership's business. This equality applies regardless of capital contribution percentages. Partners may contract around this default by specifying different management arrangements in the partnership agreement. Answer A is incorrect because capital contribution size does not determine management rights unless the agreement specifies otherwise. Answer B is incorrect because there is no designated 'managing partner' requirement by default. Answer D is incorrect because management rights vest immediately upon becoming a partner.
