Chapter 34:
Corporations —
Formation and Financing
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§ 1: 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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Nature of the Corporation [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.
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Corporate 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.
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Corporate Personnel [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).
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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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Constitutional Rights of
Corporations [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.
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Constitutional Rights of
Corporations [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.
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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 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.
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§ 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.
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Express Corporate Powers
[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.
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Implied Corporate Powers [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.
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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.
– Case 34.1: Oakley v. Longview Owners (1995).
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§ 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.
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Classification of Corporations [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).
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Classification of Corporations [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.
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§ 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.
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Incorporation Process
Promotion
File Articles of
Incorporation
Name
Search
State
Charter
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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
investors via subscription agreements.
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Promoter’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 preincorporation contracts on behalf of the
corporation, unless 3rd party agrees to hold
future corporation liable.
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Promoter’s Liabilities
[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.
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Articles 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.
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Articles of Incorporation [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.
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Articles of Incorporation [3]
• 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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Articles of Incorporation [4]
• 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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§ 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.
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Improperly Formed
Corporations
• 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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§ 6: 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. Case 34.3 Hoskins Chevrolet
v. Hochberg (1998).
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Piercing 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.
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©2001 West Legal Studies in Business. All Rights Reserved.
§ 7: Corporate Financing
• Bonds
–
–
–
–
–
v.
Debt
Fixed ROI
No votes
Optional
Priority over stock
Stocks
Ownership/equity
Dividends (variable)
Vote for Management
Required
Paid last
• Stocks: Common vs. Preferred
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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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©2001 West Legal Studies in Business. All Rights Reserved.
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.
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Emerging Trends
• Incorporate Online at
http://www.bizfilings.com/index.html
• DelawareInc.com
• The Company Corporation
• NCCF.com
Return
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