Corporations
Chapter 20
Basics of Corporations
• 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).
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,
liberty, or property.
Constitutional Rights of
Corporations
• Corporation’s rights (cont’d):
– Freedom from unreasonable search and seizure
and double jeopardy.
– Freedom of speech.
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.
Corporate 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.
• Profits from a regular “C” corporations are taxed
twice: at the corporate level and at the shareholder
level.
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.
Corporate Powers
• A corporation may act and enter into contracts as
any natural person, except as limited by:
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U.S. Constitution.
State constitutions.
State statutes.
Its own articles of incorporation.
Its own corporate bylaws.
Resolutions by its own board.
Express 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.
Implied 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.
Classification Of Corporations
• Domestic corporation does business in its
state of incorporation.
• Foreign corporation from one state doing
business in another state.
• Alien Corporation: formed in another
country doing business in United States.
Corporation Formation
• The process of incorporation generally
involves two steps:
– Preliminary and Promotional Activities;
and
– The Legal Process of Incorporation.
Promoter’s Liabilities
• Promoter is personally liable for preincorporation contracts on behalf of the
corporation, unless 3rd party agrees to hold
future corporation liable.
• After corporate formation, corporation can
adopt the pre-incorporation contract and
release the promoter by creating a
“novation”.
Forming A Corporation (Legal
Process)
• 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.
Forming A Corporation (Legal
Process)
• Choose and reserve a Corporate Name.
• Name must have the proper suffix:
“Corporation,” “Incorporated,” “Company ”
or “Limited” or an abbreviation of one of
these.
Forming A Corporation (Legal
Process)
• Internal organization and rules governing
the corporation: 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.
First Organizational Meeting
• After the corporation is “chartered”
(created) a Certificate of Incorporation is
issued by the state and it 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.
Corporate Financing
• Bond - A debt security that represents
borrowing by the corporation, in accordance
with a bond indenture—a contract between
the issuing corporation and the bondholder.
- Priority right to return of capital
- Fixed or variable interest rate
Corporate Financing
• Common Stock
– Shareholder has a proportionate interest
in the corporate with regard to voting,
earnings, and net assets.
– Last to Receive Dividends or Surplus on
Dissolution
Corporate Financing
• Preferred Stock
– Shares with priority over common stock
for payment of dividends and distribution
of assets on dissolution.
– May pay fixed dividend
– May not have voting rights
Bonds v. Stocks
Bonds
Stocks
Debt
Ownership/equity
Fixed ROI
Dividends (variable)
No votes
Vote for Management
Optional
Required
Priority over stock
Paid last
Board of Directors
• 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.
Duties of Directors
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Attend Board Meetings
Adopt Policies
Authorize Major Actions
Supervise Officers & Management
Approve Dividends
Role of Corporate Officers
• Officers serve at the pleasure of the Board
of Directors (and are elected by them) but
have fiduciary duties to company as well.
• Run day-to-day operations of the corp.
• Their employment relationships are
generally governed by contract law and
employment law.
• Officers may be terminated for cause.
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, and
-Duty of Loyalty
Failure to follow these duties may subject
the officers and directors to personal
liability
Duty of Care
• Directors/officers are expected to act in
good faith and the best interests of the
corporation.
– Make informed and reasonable decisions;
– Rely on competent consultants and
experts; and
– Exercise reasonable supervision.
Duty of Care
• Directors and officers may be liable for
negligent acts that breach the standard of
due care:
– Crimes and torts committed by them
individually and/or those committed by
employees under their supervision.
– Shareholder derivative suits where
shareholder(s) sue directors on behalf of
corporation.
Duty of Care
• 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.
Duty of Loyalty
– Loyalty to corporation & shareholders
instead of personal interest
– Cannot compete with corporation
– Cannot usurp corporate opportunities
– No conflicts of interest
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.
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.
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.
Shareholder Liability
• If the corporation fails, shareholders
generally cannot lose more than their
investment.
• Shareholders are generally not liable for the
contracts or torts of the corporation.
However the corporate veil may be pierced
under:
-“Alter ego theory” or
- “Undercapitalization theory”
Shareholder 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.
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.
• Common shareholder entitled to one vote per
share (bylaws may prescribe ways to help
minority shareholders elect Directors).
Shareholders Meetings
• For special shareholder meetings:
– Notice and time of meetings must be sent
in writing to each shareholder within a
reasonable time ahead of the meeting.
– Notice must state reason for meeting and
only deal with this matter.
Shareholders Rights
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Conduct Shareholders Meetings
Vote in Person or by Proxy
Vote by Number of Shares Owned
Inspection of Books & Records
Right to Transfer Shares (unless restricted by
agreement)
• Right to buy newly issued stock (Preemptive
Rights)
• Dividends and Rights on Dissolution
Preemptive Rights
• Common law concept which is a preference
to existing shareholders to purchase a prorated share of newly-issued 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.
Dividends
• Distribution of corporate profits or income.
• Only as ordered by the Board (Shareholder
approval is not needed).
• Can be stock, cash, property, stock of other
corporations.
Failure by Directors to Declare
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.
Mergers and Consolidations
• Merger - combination of two or more
corporations with one corporation surviving
• A+B=A
• Successor assumes all liabilities and
obligations of prior corporations
Mergers and Consolidations
• Consolidation - combination of two or more
corporations with new corporation created
• A+B=C
• Successor assumes all liabilities and
obligations of prior corporations
Purchase of Assets or Stock
• Purchase of Assets - one corporation buys
assets of another corporation
• No assumption of liabilities by purchaser
(unless really a continuation of previous
company or a fraud to avoid liability)
• Selling corporation continues to exist
Purchase of Assets or Stock
• Purchase of Stock - one corporation or party
buys stock of another corporation (tender
offer)
• Control of all assets goes with stock
• Liabilities remain in corporation
• Corporation may be held as subsidiary or
merged into acquiring corporation
Termination
• Termination of a corporation consists of two
phases:
– Dissolution (voluntary or involuntary legal
“death” of the corporation); and
– Liquidation (assets converted to cash and
distributed to creditors and shareholders).
Corporations
End of Chapter 20