Business Law and the Business Law and the Regulation of BusinessRegulation of Business

Chapter 35: Financial Structure of CorporationsChapter 35: Financial Structure of Corporations

Business Law and the Business Law and the Regulation of BusinessRegulation of Business

Chapter 35: Financial Structure of CorporationsChapter 35: Financial Structure of Corporations

ByBy

Richard A. MannRichard A. Mann

&&

Barry S. RobertsBarry S. Roberts

Topics Covered in this ChapterTopics Covered in this Chapter

I.I. Debt SecuritiesDebt SecuritiesA. Authority to Issue Debt SecuritiesA. Authority to Issue Debt SecuritiesB. Types of Debt SecuritiesB. Types of Debt Securities

II.II. Equity SecuritiesEquity SecuritiesA. Issuance of SharesA. Issuance of SharesB. Classes of SharesB. Classes of Shares

III. Dividends and Other DistributionsIII. Dividends and Other DistributionsA. Types of Dividends and Other DistributionsA. Types of Dividends and Other DistributionsB. Legal Restrictions on Dividends & Other B. Legal Restrictions on Dividends & Other Distributions DistributionsC. Declaration and Payment of DistributionsC. Declaration and Payment of DistributionsD. Liability for Improper Dividends & D. Liability for Improper Dividends & Distributions Distributions

Authority to Issue Debt SecuritiesAuthority to Issue Debt Securities

Debt SecurityDebt Security – – source of capital source of capital creating no ownership interest and creating no ownership interest and involving the corporation's promise to involving the corporation's promise to repay funds lent to it.repay funds lent to it.

BondBond – – a debt security.a debt security. RuleRule – – each corporation has the power each corporation has the power

to issue debt securities as determined to issue debt securities as determined by the board of directors.by the board of directors.

Types of Debt Securities Types of Debt Securities

Unsecured Bonds Unsecured Bonds – – called called debentures; have only the obligation of debentures; have only the obligation of the corporation behind them.the corporation behind them.

Secured Bonds Secured Bonds – – are claims against are claims against a corporation's general assets and also a corporation's general assets and also liens on specific property.liens on specific property.

Income Bonds Income Bonds – – condition to some condition to some extent the payment of interest on extent the payment of interest on corporate earnings.corporate earnings.

Types of Debt Securities Types of Debt Securities

Participating Bonds Participating Bonds – – call for a call for a stated percentage of return regardless stated percentage of return regardless of earnings, with additional payments of earnings, with additional payments dependent upon earnings.dependent upon earnings.

Convertible Bonds Convertible Bonds – – may be may be exchanged for other securities.exchanged for other securities.

Callable Bonds Callable Bonds – – bonds subject to bonds subject to redemption.redemption.

Issuance of Shares Issuance of Shares

Equity Security Equity Security – – source of capital source of capital creating an ownership interest in the creating an ownership interest in the corporation.corporation.

Share Share – – a proportionate ownership interest a proportionate ownership interest in a corporation.in a corporation.

TreasuryTreasury Stock Stock – – shares reacquired by a shares reacquired by a corporation.corporation.

Authority to Issue Authority to Issue – – only those shares only those shares authorized in the articles of incorporation may authorized in the articles of incorporation may be issued.be issued.

Debt and Equity SecuritiesDebt and Equity Securities

Debt Common Preferred

Ownership Interest No Yes Yes

Obligation to RepayPrincipal

Yes No No

Fixed Maturity Yes No No

Obligation to Pay Income Yes No No

Preference on Income Yes No Yes

Preference on Liquidation Yes No Yes

Voting Rights Some states Yes, unless denied Yes, unless denied

Redeemable Yes In some states Yes

Convertible Yes In some states Yes

Issuance of Shares Issuance of Shares

PreemptivePreemptive Rights Rights – – right to purchase a right to purchase a pro pro ratarata share of new stock offerings. share of new stock offerings.

AmountAmount of Consideration for Shares of Consideration for Shares – – shares are deemed fully paid when a shares are deemed fully paid when a corporation receives the price set by the corporation receives the price set by the board of directors.board of directors.

Payment for Newly Issued Shares Payment for Newly Issued Shares – – may may be cash, property, and services actually be cash, property, and services actually rendered; under the Revised Act, promises to rendered; under the Revised Act, promises to contribute cash, property, or services are also contribute cash, property, or services are also permitted.permitted.

Issuance of SharesIssuance of Shares

Authorized

But Not Issued

Treasury

Issued

AuthorizedVOID

Outstanding

Valid Capital ContributionsValid Capital Contributions

Kind ULPA RULPA MBCA RMBCA

Cash Yes Yes Yes Yes

Property Yes Yes Yes Yes

Services rendered No Yes Yes Yes

Promise to contribute cash No Yes No Yes

Promise to contribute property No Yes No Yes

Promise to perform services No Yes No Yes

Classes of Shares Classes of Shares Common Stock Common Stock – – stock not having any stock not having any

special contract rights.special contract rights. PreferredPreferred Stock Stock – – stock having contractual stock having contractual

rights superior to those of common stock.rights superior to those of common stock.– DividendDividend Preferences Preferences – – must receive full must receive full

dividends before any dividend may be paid on dividends before any dividend may be paid on common stock.common stock.

– LiquidationLiquidation Preferences Preferences – – priority over priority over common stock in corporate assets upon common stock in corporate assets upon liquidation.liquidation.

– StockStock Options Options – – contractual right to purchase contractual right to purchase stock from a corporation.stock from a corporation.

– –

Types of Dividends and Other Types of Dividends and Other DistributionsDistributions

Distributions Distributions – – transfers of property transfers of property by a corporation to any of its by a corporation to any of its shareholders with respect to its shares.shareholders with respect to its shares.

CashCash Dividends Dividends – – the most common the most common type of distribution.type of distribution.

PropertyProperty Dividends Dividends – – distribution in distribution in form of property.form of property.

StockStock Dividends Dividends – – a ratable a ratable distribution of additional shares of stock.distribution of additional shares of stock.

Types of Dividends and Other Types of Dividends and Other DistributionsDistributions

StockStock Splits Splits – – each of the outstanding each of the outstanding shares is broken into a greater number of shares is broken into a greater number of shares.shares.

LiquidatingLiquidating Dividends Dividends – – a distribution of a distribution of capital assets to shareholders.capital assets to shareholders.

RedemptionRedemption ofof Shares Shares – – a corporation's a corporation's exercise of the right to purchase its own exercise of the right to purchase its own shares.shares.

AcquisitionAcquisition ofof Shares Shares – – a corporation's a corporation's repurchase of its own shares.repurchase of its own shares.

Legal RestrictionsLegal Restrictions

Legal Restrictions on Cash Legal Restrictions on Cash Dividends Dividends – – dividends may be paid only if dividends may be paid only if the following tests are satisfied:the following tests are satisfied:– Cash Flow Test Cash Flow Test – – a corporation must not be or a corporation must not be or

become insolvent (unable to pay its debts as they become insolvent (unable to pay its debts as they become due in the usual course of business).become due in the usual course of business).

– Balance Sheet TestBalance Sheet Testvaries among the States varies among the States and includes the earned surplus test (available in and includes the earned surplus test (available in all States), the surplus test, and the net assets test all States), the surplus test, and the net assets test (used by the Model and Revised Acts).(used by the Model and Revised Acts).

Other Legal Restrictions Other Legal Restrictions

Legal Restrictions on Liquidating Legal Restrictions on Liquidating Distributions Distributions – – States usually permit States usually permit distribution in partial liquidation from capital distribution in partial liquidation from capital surplus unless the company is insolvent.surplus unless the company is insolvent.

Legal Restrictions on Redemptions of Legal Restrictions on Redemptions of Shares Shares – – in most States, a corporation may in most States, a corporation may not redeem shares when insolvent or when not redeem shares when insolvent or when such redemption would render it insolvent.such redemption would render it insolvent.

Legal Restrictions on Acquisition of Legal Restrictions on Acquisition of Shares Shares – – restrictions similar to those on cash restrictions similar to those on cash dividends usually apply.dividends usually apply.

Key Concepts in Legal Restrictions Key Concepts in Legal Restrictions upon Distributionsupon Distributions

Liabilities

(Liquidation Preferences)

Stated Capital(contributed capital*)

Capital Surplus(contributed capital in excess

of par or stated value*)

Earned Surplus(retained earnings*)

Surplus

NetAssetsTotal

Assets

*Accounting terminology

Declaration and Payment of Declaration and Payment of DistributionsDistributions

Shareholders' Right to Compel a Shareholders' Right to Compel a Distribution Distribution – – the declaration of the declaration of distributions is within the discretion of distributions is within the discretion of the board of directors, and only rarely the board of directors, and only rarely will a court substitute its business will a court substitute its business judgment for that of the board's.judgment for that of the board's.

Effect of Declaration Effect of Declaration – – once properly once properly declared, a distribution is considered a declared, a distribution is considered a debt the corporation owes to the debt the corporation owes to the shareholders.shareholders.

Liability for Improper Liability for Improper Dividends and DistributionsDividends and Distributions

Directors Directors – – the directors who assent to the directors who assent to an improper dividend are liable for the an improper dividend are liable for the unlawful amount of the dividend.unlawful amount of the dividend.

Shareholders Shareholders – – a shareholder must a shareholder must return illegal dividends if he knew of the return illegal dividends if he knew of the illegality, if the dividend resulted from illegality, if the dividend resulted from his fraud, or if the corporation is his fraud, or if the corporation is insolvent.insolvent.

Liability for Improper DistributionsLiability for Improper Distributions

Corporation Solvent Corporation Insolvent

NonbreachingDirector

No No

Breaching Director Yes Yes

Knowing Shareholder Yes Yes

Innocent Shareholder No Yes