February 2016 Example Ten-point Answers to Virginia Essay Questions
February 2016 - QUESTION 2 – VIRGINIA BAR EXAMINATION
Jake and Ellwood, both Hampton, Virginia, residents, are electricians who duly formed Jake and Ellwood, Inc., ("J&E"), as a closely held Virginia corporation for the purpose of teaming up to bid on large electrical jobs. Each man paid $5,000 in cash for the corporation's stock. No other capital investment was made in the business.
To run the business, Jake and Ellwood brought in Sally to serve as president and treasurer of J&E. Sally owned no stock but was a member of the Board of Directors.
J&E was subsequently awarded a $100,000 contract to wire electricity in an office building in Hampton. The corporation subcontracted all the labor for the job to a third party. Sally ordered $60,000 worth of electrical supplies on open account from Electric Supply House, Ltd. ("Electric Supply"), a Newport News, Virginia, supply firm, and these supplies were properly invoiced to J&E. The supplies were used and the job completed.
Several months after the office building had been completed and after the time had passed in which a mechanic's lien could have been filed, an internal audit at Electric Supply revealed that it had never been paid for the electrical supplies sold to J&E. The president of Electric Supply contacted Sally to demand payment and was told the following facts:
- Shortly after the completion of the office building, J&E was properly dissolved by majority vote of the Board of Directors at a properly called meeting at which Sally was present but did not vote or explicitly abstain from voting. The dissolution resolution had been duly approved by unanimous action of the stockholders.
- The entire corporate assets, consisting of $25,000 cash, had been disbursed equally to Jake and Ellwood, the shareholders, at the time of dissolution.
- All other corporate funds were previously used to meet ordinary operating expenses.
Electric Supply immediately filed suit against J&E, Jake, Ellwood, and Sally in the Hampton Circuit Court alleging J&E's failure to pay for the electrical supplies and that the distribution of J&E's assets to the shareholders violated Virginia law. Electric Supply obtained a judgment in the amount of $25,000 against J&E, Jake, Ellwood, and Sally, declaring that the distribution did violate Virginia law. Electric Supply now seeks to enforce the judgment against Jake, Ellwood, and Sally as individuals.
The City manager asks you, as the City Attorney, the following questions:
|(a)||Was the Court correct in ruling that the distribution violated Virginia law? Explain fully.|
|(b)||What personal liability and for what amount, if any, do Jake, Ellwood, and Sally each have on the judgment? Explain fully.|
|(c)||If Sally satisfies the judgment by paying Electric Supply from her personal assets, what rights, if any, does she have to recover from Jake and Ellwood? Explain fully.|
February 2016 - QUESTION 2 – EXAMPLE ANSWER #1
At issue is a wrongful distribution from a closely held corporation upon termination of the corporation, during the period of winding up. For the reasons explained below, both the corporation and the particular parties at issue will have liabilities for the wrongful distribution and the resulting judgment.
First, under Virginia law, a closely held corporation is a corporation with only a few shareholders. Closely held corporations in some respects follow more relaxed procedures than other, more widely held corporations. The Supreme Court in the Hooby Lobby case recently made law that recognizes the unique nature of closely held corporations and the wider latitude they enjoy, for instance, to enforce their preferences on employees. Quite often the few shareholders of a closely held corporation are family members or close associates, and these few shareholders also often double as directors or officers of the corporation. In this case, it is not clear if Jake and Elwood serve on the board of directors or are offices of the corporation. I will note places at which this becomes relevant.
Part a) The Court was correct in ruling that the distribution of corporate assets to the shareholders violated Virginia law. Under Virginia law, a distribution when the corporation is insolvent are wrongful. A corporation is considered insolvent for these purposes if its debts exceed its assets, or if making the distribution will prevent the corporation from meeting its liabilities. This rule holds true at any point in a corporation's life, including during the winding up period after termination of the corporation.
In this case, shortly after completing its office building job, the J&E corporation was terminated and, during the winding up, remaining corporate assets were distributed to Jake and Elwood as shareholders. This distribution was wrongful, because the corporation had outstanding liabilities of $60,000 to Electric Supply. Because the corporation's assets of $25,000 were exceeded by its debt of $60,000, the distribution to shareholders was wronggul.
Part b) Sally is personally liable for the judgment of $25000 in favor of Electric Supply, and I believe Jake and Ellwood are too.
Under securities law, directors are liable for wrongful distributions. Distributions are wrongful when, as noted above, the corporation is insolvent. It is incumbent upon directors to monitor the liabilities of the corporation and not to give unauthorized distributions that will render the corporation insolvent or when the corporation is already insolvent. Because she is a director, Sally will be liable.
The facts note that Sally was present at the meeting when the corporation was dissolved and did not vote for it but did not explciitly abstain. A director may avoid liability for corporate decisions by objecting to the meeting at which the decision is made, and by abstaining or dissenting from the action. In this case, Sally did not object to the meeting, and she did not explicitly abstain from or dissent from the dissolution resultion. Even if she had, the distribution is a distinct decision from the decision to dissolve. It is part of the winding up, and Sally had a duty to ensure that the winding up was completed correctly.
As for Jake and Ellwood, if they are also directors of the closely held corporation, then the same analysis above applies to them as well as to Sally. If they are not officers or directors but are simply shareholders, then while the corporate form usually shields participants from personal liability, shareholders are not entitled to keep the proceeds of a wrongful distribution. Here, Jake and Elwood have been the beneficiaries of a wrongful distribution. It appears that the amount of time that has elapsed has only been a few months, which removes any concerns about statute of limitations or other timing issues. Therefore Jake and Ellwood too should be liable for the judgment.
Part c) To the extent that Jake and Ellwood are liable for the judgment, as described above, then all three individuals would be jointly and severally liable for the judgment. Virginia follows the rule of joint and several liability with the right of contribution. Joint wrongdoers are liable severally for their share of the judgment and jointly for the entire amount, subject to the right of contribution. Therefore Sally could have to pay Electric Supply the entire judgment, and then she could seek contribution from Jake or Ellwood or both.
February 2016 - QUESTION 2 – EXAMPLE ANSWER #2
a) The Hampton Circuit Court was correct in ruling that the $25,000 distribution of corporate assets violated Virginia law.
Directors have the authority to approve distributions that do not violate the Virginia Stock Corportations Act. The directors may make distributions to shareholders at any time, and in any amount, provided the distributions are not made while the corporation is insolvent, would render the corporation insolvent, or would otherwise render the corporation unable to pay its outstanding liablities or meet ongoing expenses. A corporation is considered insolvent if its outsanding liabilities exceed its outstanding assets. These rules apply whether the business is ongoing or winding up. Thus, distributions cannot be made to shareholders while winding up until all known liabilities have been paid.
Here, the $60,000 due for supplies purchased (and used) from Electric Supply was properly invoiced, so J&E was aware of the liablity. Immediately before the dissolution, J&E had assets of $25,000 in cash and outstanding liabilities of $60,000. (There are no facts to suggest that J&E had other outstanding liabilities.) Therefore, the $25,000 could not legally be distributed to the shareholders because J&E was already insolvent since its liabilities exceeded its assets at that time.
Moreover, J&E cannot legally distribute its assets to shareholders upon dissolution without paying all known outstanding liabilities. Since J&E knew of the $60,000 bill because it had been properly invoiced (and J&E had no reason to contest the liability because it actually received and used the supplies), it could not distribute the $25,000 to its shareholders because the $25,000 cash was the only remaining corporate asset and should have been applied to the Electric Supply invoice.
b) Jake, Ellwood, and Sally are personally liable for the entire $25,000 judgment, jointly and severally.
Directors owe fiduciary duties of loyalty and care to the corporations. Pursuant to the duty of care, they must make decisions as a prudent person would. However, they are generally protected from personal liability for such decisions made in good-fath pursuant to the business judgment rule. One such business decision is the approval of distributions to shareholder. Nevertheless, directors may be held personally liable for approving illegal distributions, subject to a right of indemnification that will be addressed in part (c), to the extent the distribution was illegal. Only directors who actually approved such illegal distributions can be held personally liable. If a director votes against or abstains from the vote on an illegal distribution, he/she will not be personally liable.
Here, the entire $25,000 was an illegal distribution as discussed in part (a). Jake and Ellwood voted in favor of the distribution at a properly-called meeting for that purpose, so they will be held liable. Sally will also be considered to have approved the distribution because she did not oppose it nor did she explicity abstain. Virginia considers directors to approve resolutions/actions at meetings they attend unless the director either votes against or explicitly abstains from voted on such a measure.
Therefore, since Jake, Elwood, and Sally are all considered to have approved an illegal distribution, they will be held personally liable to the extent the distribution was illegal (in this case, the entire $25,000).
c) If Sally satisfies the $25,000 judgment for an illegal distribution, she has the right to recover $12,500 from Jake and $12,500 from Elwood.
While directors who approve illegal distributions can be held personally liable to the extent such distributions are illegal, they have the right seek indemnification by disgorging such illegal distributions from the shareholders who received them.
Here, the $25,000 was disbursed equally to Jake and Elwood, thus Jake and Elwood each received $12,500. The entire $25,000 was an illegal distribution, so Jake and Elwood each received $12,500 illegally. If Sally satisfies the judgment from her personal assets, she can therefore look to Jake for the $12,500 he received illegally and look to Elwood for the $12,500 he received illegally.