BUSINESS LAW TODAY
Essentials 9th Ed.
Roger LeRoy Miller - Institute for University Studies, Arlington, Texas
Gaylord A. Jentz - University of Texas at Austin, Emeritus
Chapter
20
Corporations
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1
Learning Objectives
 What steps are involved in bringing a

corporation into existence?
In what circumstances might a court
disregard the corporate entity (“pierce the
veil”) and hold shareholders personally
liable?
 What are the duties of corporate directors and


officers?
What is a voting proxy? What is cumulative
voting?
What are the differences between a merger, a
consolidation, and a share exchange?
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2
The Nature of the Corporation
 A corporation is a legal entity, 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).
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3
Corporate Personnel
 Board of Directors: manage the big
picture, set policy, hire officers.
 Officers: manage the day-to-day
operations of the corporation.
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4
Constitutional Rights of Corporations
 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.
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5
Constitutional Rights of Corporations
 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.
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6
Limited Liability of Shareholders
 The corporation provides limited
liability for stockholders.
 In certain situations, the corporate
“veil” of limited liability can be
pierced, holding the shareholders
personally liable.
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7
Corporate Earnings and 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.
Taxation: Regular “C” corporations are taxed
twice: at the corporate level and at the
shareholder level.
Holding Companies: used to defer U.S. income
taxes (hold shares of another).
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8
Torts 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.
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9
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.
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10
Classification of Corporations
 Public and Private.
 Nonprofit.
 Close Corporations.
 Shares held by family members or very few
shareholders. Management is information, similar to a
partnership.
 Transfer of shares is restricted.
 Misappropriation of Funds is a major issue.
 CASE 20.1 Williams v. Stanford. (2008). Two
minority shareholders prevented one 70%
shareholder from transferring of corporate assets
after proving abuse and fraud.
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11
Classification of Corporations
 “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 nonresident alien.
 Professional Corporations.
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12
Corporate Formation and Powers
 The process of incorporation
generally involves two steps:
Promotional Activities; and
The Legal Process of Incorporation.
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13
Incorporation Procedures
Promotion
File Articles of
Incorporation
Name
Search
State
Charter
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Subscribers
1st Organizational Meeting
14
Selecting the State
 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 (and maybe the promoters).
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15
Securing the Corporate Name
 Choose and reserve a Corporate Name.
 Name must have the proper suffix:
“corporation,” “corp.,” “Incorporated.”
 You should also consider registering the
corporation as a “dot com” at
networksolutions.com or register.com.
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16
Preparing the Articles of Incorporation
 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.
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17
Preparing the Articles of 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.
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18
Corporate Powers
 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.
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19
Corporate Powers
 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.
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20
Corporation by Estoppel
 Corporation By Estoppel: if it acts like
a corporation, cannot avoid liability by
claiming that no corporation exists.
 CASE 20.2 Brown v. W.P. Media, Inc.
(2009). Firm that represented itself as a
corporate entity is estopped from denying
liability for breach of contract even if it was
did not exist at the time of the contract.
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21
Piercing the Corporate Veil
 “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.
 Factors a court considers:
3rd party tricked into dealing with a
corporation rather than the individual. 
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22
Issues: Piercing the Corporate Veil
 Was corporation set up to not make a profit,
remain insolvent, or be under capitalized?
 Were statutory formalities followed?
 Was the corporation an “alter ego” of a
majority shareholder, with personal and
corporate interests commingled such that
the corporation has no separate identity?
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23
Corporate Financing
Bonds
vs.
Stocks
Debt
Ownership/equity
Fixed ROI
Dividends (variable)
No votes
Vote for Management
Optional
Required
Priority over stock
Paid last
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24
Bonds
Type
Definition
Debentures
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.
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25
Stocks
 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.
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26
Venture Capital and
Private Equity Capital
 Venture Capital: start-up businesses and
high-risk enterprises need start-up and
expansion capital. The start-up typically
gives a share of its stock.
 Private Equity Capital: obtain capital
from wealthy investors. Ultimately, the
company may sell shares in an IPO.
 Locating potential investors online.
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27
Roles of Directors and Officers
 Every corporation is governed by a board of


directors.
Individual directors are not agents of
corporation, only the board itself can act as
a “super-agent” and bind the corporation.
A director can also be a shareholder,
especially in closely-held corporations.
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28
Election and
Compensation of Directors
 Subject to statutory limitations, the number
of directors is set forth in the articles of
incorporation:
 Directors appointed at the first organizational
meeting.
 In closely held companies, directors are generally the
incorporators and/or the shareholders.
 Term of office is generally for one year.
 Director can be removed for cause (for failing to
perform a required duty).
 In very large companies, directors can be
compensated, and may be officers as well.
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29
Board of Directors’ Meetings
 Directors hold meetings pursuant to
bylaws with recorded minutes.
 Special meetings may be called with
sufficient notice.
 Meetings require QUORUM (minimum
number of directors to conduct official
corporate business, usually majority).
 Each director generally has one vote.
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30
Rights of Directors
 Directors have the right to:
Participate in corporate decisions and
inspect corporate books and records.
Compensation (usually a nominal sum)
and indemnification. If a director is sued
for acts as director, the corporation
should guarantee reimbursement
(indemnification) or purchase liability
insurance to protect the board from
personal liability.
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31
Committees of the Board of Directors
 With large numbers of directors,
various sub-committees can be formed:
Executive Committee.
Audit Committee.
Nominating Committee.
Compensation Committee.
Litigation Committee.
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32
Corporate Officers and Executives
 Officers serve at the pleasure of the
Board of Directors but have fiduciary
duties to company as well.
 Their employment relationships are
generally governed by contract law and
employment law.
 Officers may be terminated for cause.
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33
Duties and Liabilities of
Directors and Officers
 Directors and officers are fiduciaries of

the corporation. They owe ethical and
legal duties to the corporation and
shareholders:
Duty of Care : Directors/officers are
expected to act in good faith and the best
interests of the corporation. Failure to
exercise due care may subject individual
directors or officers personally liable.
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34
Duties and Liabilities of
Directors and Officers
 Duty of Care (cont’d):
 Make informed and reasonable decisions;
 Rely on competent consultants and experts; and
 Exercise reasonable supervision.
 A dissenting director is rarely held liable
for mismanagement of corporation.
Dissent must be registered with the
corporate secretary and posted in the
minutes of the meetings.
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35
Duty of Loyalty

Duty of Loyalty: subordination of personal
interests to the welfare of the corporation.
 No competition with Corporation.
 No “corporate opportunity.”
 No conflict of interests.
 No insider trading.
 No transaction that is detrimental to minority
shareholders.
 CASE 20.3
Guth v. Loft, Inc. (1939). Guth
violated his fiduciary duty by acquiring the Pepsi-Cola
trademark for himself, putting himself in a competitive
position with the company he worked for.
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36
Business Judgment Rule
 Immunizes a director or officer from
liability from consequences of a
business decision that turned sour.
 Court will not require directors or
officers to manage “in hindsight.”
 As long as decision was reasonable,
informed, made in good faith and in the
best interests of the corporation, BJR
will apply.
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37
Conflicts of Interest
 Full disclosure of any potential
conflicts of interest and abstain from
voting on any transaction that may
benefit the director/officer personally.
 However, if transaction was fair and
reasonable, it will not be voidable if
approved by majority of disinterested
directors.
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38
Role of Shareholders
 Ownership of shares grants a shareholder


an equitable ownership interest in a
corporation.
Shareholders generally have no right to
manage the daily affairs of the corporation,
but do so indirectly by electing directors.
Shareholders are generally protected from
personally liability by the corporate veil of
limited liability.
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39
Shareholders’ Powers
 Shareholder powers include approving
all fundamental changes to the
corporation:
Amending articles of incorporation or
bylaws.
Approval of mergers or acquisition.
Sale of all corporate assets or
dissolution.
 Shareholders also elect and remove the
board of directors.
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40
Shareholders’ Meetings
 Shareholders’ meetings must occur at
least annually. Voting requirements
and procedures are:
Quorum of shareholders owning more than
50% of shares must be present to conduct
business;
Shareholders may appoint a proxy or enter
into a voting trust agreement.
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41
Shareholder Voting
 Common shareholder entitled to one vote



per share.
Articles and by-laws can exclude or limit
voting rights of certain classes of stock.
Quorum must be present -- shareholders
representing more than 50% of
outstanding shares must be present.
Cumulative Voting: allows minority
shareholders to get a board member
elected.
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42
Rights of Shareholders
 Shareholders have the right:
To vote.
To have a stock certificate.
To purchase newly issued stock.
To dividends, when declared by board.
To inspect corporate records.
To transfer shares, with some exceptions.
To a proportionate share of corporate assets
on dissolution.
To file suit on behalf of corporation.
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43
Preemptive Rights
 Common law concept which is a
preference to existing shareholders to
purchase a pro-rated share of newlyissued stock within a certain period of
time.
 Provided for in the articles of
incorporation.
 Significant in a close corporation to
prevent dilution and loss of control.
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44
Dividends
 Distribution of corporate profits or
income.
 Only as ordered by the Board.
 Can be stock, cash, property, stock of
other corporations.
 State laws control the sources of
revenues for dividends, which may be
paid from retained earnings, net
profits and surplus.
 What are “illegal dividends”?
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45
Directors’ Failure to Declare a Dividend
 When directors fail to declare a dividend,


shareholders can sue.
Directors do not have to declare if they have
a rational basis for withholding a dividend (a
bona fide purpose).
Often, profits are retained for expansion,
research or upgrades.
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46
Inspection Rights
 Shareholders can inspect books for a
proper purpose.
But corporation can protect trade secrets, other
confidential information.
Shareholder must have held a minimum number
of shares for a minimum amount of time.
 All shareholders can see list of other
shareholders of record.
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47
Transfer of Shares
 Shares are freely transferable unless



restricted by articles and noted on the
stock certificate.
Closely held corporations may have “right
of first refusal” or preemptive rights.
Transfer accomplished by delivery or
endorsement to corporate secretary.
New shareholder must be recorded on
corporate books.
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48
The Shareholder’s Derivative Suit
 Shareholders can sue a 3rd party on
behalf of the corporation if the
Directors fail or refuse to correct the
wrong or injury.
 Directors may refuse to take action
because they might personally be
liable.
 Any damages recovered go to
corporation’s treasury.
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49
Duties and Liabilities of Shareholders
 Shareholders are generally not liable for
the contracts or torts of the corporation.
 If the corporation fails, shareholders
cannot lose more than their investment,
except when:
A shareholder hasn’t paid for stock pursuant to
the stock subscription agreement.
Shareholder buys “watered stock” which is
below the stock’s par value.
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50
Duties of Majority Shareholders
 Majority shareholders own enough shares to

exercise de facto (actual) control over the
corporation.
Majority shareholders owe a fiduciary duty to
corporation and the minority shareholders
and creditors when they sell their shares
because of the possibility of transfer of
control.
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51
Mergers and Acquisitions
 Corporations can grow and expand by:
Mergers.
Consolidation.
Purchase of another corporation’s assets.
Purchases of a controlling interest in another
corporation.
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52
Merger
 Legal combination of two
or more corporations (A &
B) after which only A
corporation remains. A’s
articles of incorporation are
amended to include articles
of merger.
 After merger, A continues
as the surviving
corporation with all of B’s
rights and obligations.
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A
B
A
53
Consolidation
 Occurs when two or more

corporations (A & B)
combine such that both
cease to exist and a new
corporation emerges which
has all the rights and
obligations previously held
by A and B.
C’s articles of consolidation
take the place of the original
articles of A and B.
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A
B
C
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Share Exchange
 Some or all of the shares of one corporation
are exchanged for some or all of the shares
of another corporation, but both corporations
continue to exist.
 Share exchanges are often used to create
holding companies.
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Merger, Consolidation and
Share Exchange Procedures



Board of directors of each corporation
involved must approve the merger
plan.
Next shareholder approval of each
corporation.
Then, articles filed with Secretary of
State and who issues a certificate of
merger to the surviving corporation or
a certificate of consolidation to the
newly consolidated corporation.
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Merger, Consolidation and
Share Exchange Procedures
 When allowed by state statute, a
shareholder has the right to dissent
and be bought out” of his/her shares
(shareholder’s appraisal right).
 In cases of: merger, consolidation,
purchase of assets not in the ordinary
course of business, adverse
amendments to the articles of
incorporation.
 Short-Form Mergers.
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Appraisal Rights
 Appraisal Rights.
Make written offer to purchase a
dissenting shareholder’s stock,
accompanied by current balance sheet
and income statement for the corporation.
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Purchase of Assets and Potential Liability
 Sale of Corporate Assets.
Occurs when a corporation acquires all or
substantially all of the assets of another
corporation by direct purchase.
The purchasing, or acquiring corporation simply
extends its ownership and control over more
assets.
Shareholder approval is not required because
there is no change in the legal entity.
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


Purchase of Assets and
Potential Liability
General Rule: corporation that purchases the assets
of another corporation is not automatically responsible
for the liabilities of the selling corporation.
Exceptions to the rule are:
 1 . When purchasing corporation assumes the seller’s
liabilities.
 2 . When transaction is actually a merger or consolidation.
 3. When purchasing corporation is a continuation of the
selling corporation (same operations and personnel).
 4. When sale is entered into fraudulently for the purpose of
escaping liability.
In any of these situations, the acquiring corporation
will be held to have assumed both the assets and the
liabilities of the selling corporation.
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Purchase of Stock and Tender Offers
 Alternative to merger or consolidation is

the purchase of a controlling interest
(e.g., 51%) of a “target” corporation’s
stock (called a “takeover”) giving the
purchaser corporation controlling interest
in the target.
The aggressor deals entirely with the
target’s shareholders.
Proxy Fight, Leveraged Buyout.
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Purchase of Stock and Tender Offers
 Tender Offers.
A publicly advertised offer addressed to all
shareholders of the target is called a tender
offer.
Tender offer is usually higher than market
value per share but conditioned on the
acquisition of a certain % of shares.
• Can be in exchange for aggressor's stock.
• Sec strictly regulates tender offers.
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Responses to Tender Offers: Defenses
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63
Termination
 Termination of a corporation, like a
partnership, consists of two phases:
 Dissolution (voluntary or involuntary); and
 Liquidation.
 Dissolution can brought about by:
 Act of legislature.
 Certificate expiration.
 Voluntary approval by shareholders and board.
 Unanimous action by all shareholders.
 Court order.
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Voluntary Dissolution
 Shareholders can initiate dissolution by
a unanimous vote to dissolve.
 Or, the Board can initiate by submitting a
proposal to the shareholders for a vote at
the annual shareholder meeting or
specially-called meeting.
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Involuntary Dissolution
 Secretary of State or Attorney General
can dissolve if Corporation:
 Fails to pay taxes.
 Fails to file annual report.
 Fails to designate registered agent for service.
 Secured its charter through fraud.
 Abused its corporate power.
 Violated criminal laws.
 Failed to commence business operations.
 Abandoned operations before start-up.
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Involuntary Dissolution
 Court can dissolve a corporation if:
Board is deadlocked and irreparable damage to
corporation will ensue.
Mismanagement.
Minority shareholder is “frozen out” or
oppressed.
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Termination and Winding Up
 Board liquidates and acts as trustees
of assets. Court will appoint a receiver
if:
Board refuses; or
Creditors want a receiver.
 Winding Up.
Directors act as trustees of corporate assets,
and personally liable.
Courts may also appoint a receiver to wind up
the corporate affairs.
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