chapter 34: corporations — formation and financing

©2001 West Legal Studies in Business. All Rights Reserved.1

Chapter 34:Chapter 34:Corporations — Corporations —

Formation and FinancingFormation and Financing


§ 1: The Nature of the § 1: The Nature of the CorporationCorporation

• A corporation is a creature of statute, an artificial “person.”– Most states follow the Model Business

Corporation Act (MBCA) or the RMBCA, that are model corporation laws.

• The shares (stock) of a corporation are owned by at least one shareholder (stockholder).


Nature of the Corporation Nature of the Corporation [2][2]

• The corporation substitutes itself for the natural persons in conducting corporate business and incurring liability, but its authority and liability are separate and apart from the shareholders.

• In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable.


Corporate PersonnelCorporate Personnel

• Individual shareholders own corporation.• Shareholders elect board of directors to

manage corporation.• Board of directors hires officers to run

corporation on a daily basis.


Corporate Personnel Corporate Personnel [2][2]

• Body of shareholders can change constantly without affecting the continued existence of the corporation.

• Shareholder can sue corporation and be sued by corporation and bring suit for corporation in some instances (derivative action).


Corporate TaxationCorporate Taxation

• Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends.

• Corporate profits are taxed under federal and state law as a separate “person” from its shareholders.

• Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level.


Constitutional Rights of Constitutional Rights of Corporations Corporations [1][1]

• A corporation is an artificial “person” and has constitutional rights to:– Equal protection; – Access to the courts, can sue and be sued;– Right to due process before denial of life,

liability or property.


Constitutional Rights of Constitutional Rights of Corporations Corporations [2][2]

• Corporation’s rights (cont’d):– Freedom from unreasonable search and seizure

and double jeopardy.– Freedom of speech.

» Only officers and directors have protection against self-incrimination.

– However, corporations do not have full protection of privileges and immunities clause.


Torts and Criminal ActsTorts and Criminal Acts

• A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior.

• Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison.


Corporate Sentencing GuidelinesCorporate Sentencing Guidelines

• Federal Organizational Corporate Sentencing Guidelines provide specific sentencing guidelines for crimes committed by corporate employees (white collar crime).– 32 levels of offenses:

» Culpability score.» Credits can be applied.


§ 2: Corporate Powers§ 2: Corporate Powers• A corporation may act and enter into

contracts as any natural person, except as limited by:– U.S. Constitution.– State constitutions.– State statutes.– Its own articles of incorporation.– Its own corporate bylaws.– Resolutions by its own board.


Express Corporate Powers Express Corporate Powers [2][2]

• The express powers of a corporation are found in the corporation’s articles of incorporation, the laws of the state of incorporation, and in the state and federal corporations.

• Corporate by-laws may also grant or limit a corporation’s express powers.


Implied Corporate Powers Implied Corporate Powers [3][3]

• Corporation has implied powers to: to perform all acts reasonably necessary to accomplish its corporate purposes, e.g.,:

» Borrow and lend money.» Extend credit.» Make charitable contributions.

– A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise.


Ultra ViresUltra Vires Doctrine Doctrine

• Corporate acts are beyond the express or implied powers of the corporation as stated in state statute or the corporation’s own articles of incorporations and are considered to be “ultra vires” (beyond the powers).

• Corporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation.


Ultra ViresUltra Vires Doctrine Doctrine [2][2]

• The Following remedies are available for ultra vires acts: – Shareholders can bring action for

corporation.– Corporation can recover damages from its

officers and directors.– Attorney general of state may bring action to

dissolve corporation for ultra vires acts.– Case 34.1: Oakley v. Longview Owners (1995).


§ 3: Classification of Corporations§ 3: Classification of Corporations

• Domestic corporation does business in its state of incorporation.

• Foreign corporation from X state doing business in Z state.

• Alien Corporation: formed in another country doing business in United States.


Classification of Corporations Classification of Corporations [2][2]

• Public and Private.• Nonprofit.• Close Corporations.

– Shares held by few shareholders.– More informal management,similar to a

partnership.– Restriction on transfer of shares.– Case 34.2: Crowder Construction v. Kiser

(1999).


Classification of Corporations Classification of Corporations [3][3]

• “S Corporations”: Avoids the federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. IRS requirements:– Corporation is domestic, fewer than 75

shareholders, only one class of stock, no shareholder can be a non-resident alien.

• Professional Corporations.


§ 4: Corporate Formation§ 4: Corporate Formation

• The process of incorporation generally involves two steps:– Preliminary and Promotional Activities;

and– The Legal Process of Incorporation.

• Emerging Trends: On-Line Incorporation.


Incorporation ProcessIncorporation Process

Promotion

Name Search

File Articles of Incorporation

Subscribers

1st Organiza-tional Meeting

State Charter


Promotional ActivitiesPromotional Activities

• Before corporation is formed, promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements.


Promoter’s LiabilitiesPromoter’s Liabilities

• A Promoter (or corporation) can create a prospectus required by federal and state securities laws to inform and protect investors.

• Promoter is personally liable for pre-incorporation contracts on behalf of the corporation, unless 3rd party agrees to hold future corporation liable.

http://www.seic.com/prospectuses/indexa.pdf


Promoter’s Liabilities Promoter’s Liabilities [2][2]

• After corporate formation, corporation can adopt the pre-incorporation contract and release the promoter by creating a “novation”.

• Subscribers and Subscription Agreements: continuing contracts to purchase stock. Generally, subscribers become stockholders upon corporate formation.


Articles of IncorporationArticles of Incorporation

• State Chartering:– Select state (some states such as Delaware cater

to corporations).– Articles of Incorporation: primary enabling

document filed with the Secretary of State that includes basic information about the corporation. Person(s) who execute the articles are the incorporators.

– See sample incorporation rules at the Texas Secretary of State.

http://www.state.de.us/corp/index.htm

http://www.lectlaw.com/forms/f163.txt

http://www.sos.state.tx.us/function/forms/201.pdf


Articles of Incorporation Articles of Incorporation [2][2]

• Choose and reserve a Corporate Name: (Example: name search at Texas Secretary of State). Name must have the proper suffix: “corporation,” “corp.,” “Incorporated.”

• You should also consider registering the corporation as a “dot com” at networksolutions.com or simplenet.com.

http://www.sos.state.tx.us/function/forms/501.pdf

http://www.sos.state.tx.us/function/sosda1/index.html

http://www.networksolutions.com/

http://www.networksolutions.com/

http://www.simplenet.com/

http://www.simplenet.com/



• Purpose: trend towards “any legal business.”

• Duration: usually perpetual.• Capital Structure: Most states requires some

minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation.



• Internal Organization: usually included in the bylaws.

• Registered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3rd parties.

• Incorporators (usually the promoter): at least one with name and address.



First Organizational MeetingFirst Organizational Meeting

• After the corporation is “chartered” (created) it and can do business.

• Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities.



§ 5: Improper Incorporation§ 5: Improper Incorporation

• Errors in incorporation procedures when a 3rd party seeks to bring an action against a corporation that may not have complied perfectly with every incorporation law.

• Problematic for shareholders who may be personally liable.

• In addition, entity may not be able to enforce contracts.


Improperly Formed Improperly Formed CorporationsCorporations

• De Jure: substantial statutory requirements are met; cannot be attacked by state or 3rd parties.

• De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law;corporate status can only be attacked by state.

• By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists.


§ 6: Disregarding the§ 6: Disregarding theCorporate EntityCorporate Entity

• “Piercing the Corporate Veil” occurs when a court, in the interest of justice or fairness,” holds shareholders personally liable for corporate acts.

• Court concludes that shareholders used corporation as a “shield” from illegal activity. Case 34.3 Hoskins Chevrolet v. Hochberg (1998).


Piercing the Corporate VeilPiercing the Corporate Veil• Factors a court considers:

– 3rd party tricked into dealing with a corporation rather than the individual.

– Corporation is set up never to make a profit or remain insolvent or is under capitalized.

– Statutory formalities are not followed.– Corporation is “alter ego” of majority

shareholder and personal and corporate interest are commingled such that the corporation has no separate identity.


§ 7: Corporate Financing§ 7: Corporate Financing

• Bonds v. Stocks– Debt Ownership/equity– Fixed ROI Dividends (variable)– No votes Vote for Management– Optional Required– Priority over stock Paid last

• Stocks: Common vs. Preferred


BondsBondsType DefinitionDebentures No specific corporate assets are pledged as collateral.

Backed by corporation’s general credit rating.

Mortgages Pledge specific real estate. If corporation defaults, bondholders can foreclose.

Convertible Conditions trigger bonds to convert to corporate stock.

Callable Can be “called in” by principal and repaid according to bond conditions.


StocksStocks

• Common Stock: represents true ownership of a corporation. Provides pro-rata (proportional) ownership interest reflected in control, earnings and assets.

• Preferred Stock: has preferences over common stock.– Cumulative Preferred.– Participating Preferred.– Convertible Preferred.– Redeemable or Callable Preferred.


Law on the Web Law on the Web

• State Corporation Statutes at Cornell U.• The Texas Business Corporation Act.• Center for Corporate Law at Cincinnati U

College of Law.• FAQ’s on incorporation at Bizfilings.com

• Legal Research Exercises on the Web.


Emerging TrendsEmerging Trends

• Incorporate Online at http://www.bizfilings.com/index.html

• DelawareInc.com• The Company Corporation• NCCF.com

Return

http://www.bizfilings.com/index.html

http://www.delawareinc.com/

http://www.delawareinc.com/

http://www.incorporate.com/

chapter 34: corporations — formation and financing

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