Chapter 30
Corporate Formation
and Financing
Learning Objectives
 What are the express and implied powers of
corporations?
 What steps are involved in bringing a
corporation into existence?
 What is the difference between a de jure and de
facto corporation?
 When might a court disregard the corporate
entity and hold shareholders personally liable?
 How are corporations financed?
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The Nature of the Corporation
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).
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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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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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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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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.
Regular “C” corporations are taxed twice: at
the corporate level and at the shareholder level.
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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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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.
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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.
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Implied 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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Ultra Vires 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.
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Ultra Vires Doctrine [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.
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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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Classification of Corporations
Public and Private.
Nonprofit.
Close Corporations.
Shares held by few shareholders.
More informal management,similar to a
partnership.
Restriction on transfer of shares.
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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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Corporate Formation
The process of incorporation
generally involves two steps:
Preliminary and Promotional Activities;
and
The Legal Process of Incorporation.
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Incorporation Process
Promotion
File Articles of
Incorporation
Name
Search
State
Charter
Subscribers
1st Organizational Meeting
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Promotional Activities
 Before corporation is formed, promoters
are the persons who take the preliminary
steps of organizing the venture and
attracting subscribers (investors) via
subscription agreements.
 A Promoter (or corporation) can create a
prospectus required by federal and state
securities laws to inform and protect
investors.
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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”.
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Incorporation Procedures
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.
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Incorporation Procedures
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 register.com.
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Incorporation Procedures
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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Incorporation Procedures
 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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First 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.
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Corporate Status
 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.
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Corporate Status
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.
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Disregarding the Corporate 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.
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Disregarding the Corporate Entity
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.
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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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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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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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