Chapter 15: Corporations
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Corporate Nature and Classification
 A corporation is a creature of statute,
an artificial “person.”
• Corporations can have one or more
shareholders.
• Owners can be natural persons or
other businesses.
• Corporation substitutes itself for
shareholders.
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Corporate Nature and Classification
 Corporations are recognized as legal
“persons” and enjoy virtually same
rights and privileges under our
Constitution as natural persons.
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Corporate Nature and Classification
 Corporate Personnel.
• Responsibility for overall management
of company rests with board of
directors (elected by shareholders).
• Board of directors makes policy
decisions and hires officers to run
corporation on a daily basis. 
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Corporate Nature and Classification
 Corporate Personnel.
• Shareholders can sue corporation and
be sued by corporation and bring suit
for corporation in some instances.
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Corporate Nature and Classification
 Limited Liability of Shareholders.
• One of the key advantages of
corporations is the limited liability of
shareholders
• In certain situations, the corporate
“veil” of limited liability can be pierced,
holding the shareholders personally
liable.
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Corporate Nature and Classification
 Corporate Earnings and Taxation.
• Corporate profits can either be kept as
retained earnings or passed on to the
shareholders as dividends.
• Corporate Taxation: corporate taxes
can be taxes twice, first to the
corporation, then to the shareholders
via dividends. 
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Corporate Nature and Classification
 Torts and Criminal Acts.
• 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. 
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Corporate Nature and Classification
 Torts and Criminal Acts.
• Corporation can be liable for criminal
acts, but only fined.
• Responsible officers may go to prison.
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Corporate Nature and Classification
 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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Corporate Nature and Classification
 Classification of Corporations.
• Public and Private Corporations.
• Nonprofit Corporations. 
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Corporate Nature and Classification
 Classification of Corporations.
• Closely Held Corporations.
• Management of Closely Held Corporations.
• Transfer of Shares
• Shareholder Agreement to Restrict Stock.
• Misappropriation of Closely Held
Corporation Funds.
• CASE 15.1 RUBIN V. MURRAY (2011). How
would you determine reasonable
compensation?
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Corporate Nature and Classification
 Classification of Corporations.
• “S” Corporations: avoids federal tax
under IRS Code “Subchapter S.”
• Avoids federal “double taxation” of regular
corporations at the corporate level. Only
dividends are taxed to the shareholders as
personal income. 
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Corporate Nature and Classification
 Classification of Corporations.
• “S” Corporations: avoids federal tax
under IRS Code “Subchapter S.”
• IRS requirements: Corporation is
domestic, fewer than 100 shareholders,
only one class of stock, no shareholder
can be a non-resident alien.
• Professional Corporations.
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Corporate Formation and Powers
 The process of incorporation
generally involves two steps:
• Preliminary and Promotional Activities;
and 
• The Legal Process of Incorporation.
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Corporate Formation and Powers
 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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Corporate Formation and Powers
 Promotional Activities.
• Promoter’s Liability: Promoter is
personally liable for pre-incorporation
contracts on behalf of the corporation,
unless 3rd party agrees to hold future
corporation liable.
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Corporate Formation and Powers
 Incorporation Procedures.
Promotion
File Articles of
Incorporation
Name
Search
State
Charter
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Subscribers
1st Organizational Meeting
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Corporate Formation and Powers
 Incorporation Procedures.
• Select State of Incorporation.
• Secure the Corporate Name.
• Must include words that disclose corporate
status.
• Cannot infringe on another’s trademark
name. 
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Corporate Formation and Powers
 Incorporation Procedures.
• Prepare the Articles of Incorporation:
which deals with shares, the registered agent
and office, incorporators, duration and
purpose, and internal organization.
• File the articles with the state.
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Corporate Formation and Powers
 First Organizational Meeting.
• Adopt Bylaws:
• After the corporation is “chartered”
(created) it can do business.
• At meeting, shareholders should approve
the bylaws, elect directors, hire officers
and ratify pre-incorporation contracts and
activities.
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Corporate Formation and Powers
 Improper Incorporation.
• 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; can only be
attacked by state.
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Corporate Formation and Powers
 Improper Incorporation.
• Corporation by Estoppel: If it acts like a
corporation, it cannot avoid liability by
claiming that no corporation exists.
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Corporate Formation and Powers
 Corporate Powers.
• Express Powers.
• 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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Corporate Formation and Powers
 Corporate Powers.
• Implied Powers.
• To perform all acts reasonably necessary to
accomplish its corporate purposes.
• A corporate officer can bind corporation in
contract in matters connected with the
ordinary business affairs of the enterprise.
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Corporate Formation and Powers
 Corporate Powers.
• Ultra Vires Doctrine.
• Corporate acts beyond the express or
implied powers of the corporation (by
statute of articles of incorporation).
• Corporate articles of incorporations now
adopt very broad purposes to prevent
lawsuits against the corporation.
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Piercing the Corporate Veil
 In certain situations, courts will
“pierce the corporate veil” and hold
shareholders personally liable in the
interests of justice and fairness. 
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Piercing the Corporate Veil
 Factors That Lead Courts to Pierce.
• A party is 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. 
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Piercing the Corporate Veil
 Factors That Lead Courts to Pierce.
• Corporation is formed to evade an
existing legal obligation.
• Statutory formalities are not followed.
• Commingling of personal and
corporate interests or assets.
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Piercing the Corporate Veil
 A Potential Problem for Closely Held
Corporations.
• CASE 15.2 SCHULTZ V. GENERAL ELECTRIC
HEALTHCARE FINANCIAL SERVICES (2010).
Why was Schultz personally liable?
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Directors and Officers
 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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Directors and Officers
 Directors.
• Election of Directors.
• Generally, 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. 
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Directors and Officers
 Directors.
• Election of Directors.
• Removal of Directors: directors can be
removed for cause.
• Vacancies on Board: if director dies or
resigns or new position created by the
articles or bylaws.
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Directors and Officers
 Directors.
• Compensation of Directors.
• Inside director (officer), vs. outside director.
Often the same person is both an officer and
director, and receives compensation as an
officer.
• Board of Directors’ Meetings.
• Quorum must be present to conduct official
business. 
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Directors and Officers
 Directors.
• Committees of the Board.
• Executive Committee.
• Audit Committee.
• Nominating Committee.
• Compensation Committee.
• Litigation Committee.
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Directors and Officers
 Directors.
• Rights of Directors.
• Participate in corporate decisions and
inspect corporate books and records.
• Compensation (usually a nominal sum).
Corporation should guarantee
reimbursement or purchase liability
insurance to protect the board from personal
liability.
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Directors and Officers
 Corporate Officers and Executives.
• Officers serve at the pleasure of the Board
of Directors but have fiduciary duties to
company.
• Their employment relationships are
generally governed by contract law and
employment law.
• Officers may be terminated for cause.
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• Directors and officers are fiduciaries and
owe the company ethical and legal duties.
• Duty of Care.
• Duty to Make Informed Decisions. Directors are
expected to be fully informed on corporate
matters. 
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• Duty of Care (cont’d).
• Duty to Exercise Reasonable Supervision.
Directors are expected to supervise officers
when delegated work.
• Dissenting Directors: rarely held individually
liable to the corporation.
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• Business Judgment Rule: immunizes a director
or officer from liability from bad decisions.
• Court will not require directors or officers to
manage “in hindsight.” BJR will apply as long
as decision was reasonable, informed, made
in good faith and best interests of the corp.
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• 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. 
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• Duty of Loyalty.
• No transaction that is detrimental to minority
shareholders..
• CASE 15.3 GUTH V. LOFT, INC. (1939). What were
the two parts of the duty test the court used to
determine whether the corporate executives had
violated their duty of loyalty?
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Directors and Officers
 Duties and Liabilities of Directors and
Officers.
• Disclosure of Potential Conflicts of
Interest.
• Directors and officers must provide full disclosure
of any potential conflicts of interest and abstain
from voting on any transaction that may benefit
the director/officer personally.
• If reasonable, can be approved.
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Shareholders
 Shareholders generally have no right to
manage the daily affairs of the
corporation, but do so indirectly by
electing directors.
 Controlling shareholders owe a
fiduciary duty to minority shareholders.
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Shareholders
 Shareholder Powers.
• 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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Shareholders
 Shareholders’ Meetings.
• Must occur at least annually. Voting
requirements and procedures are:
• Notice of Meetings.
• Proxies.
• Shareholder Proposals.
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Shareholders
 Shareholders’ Meetings.
• Shareholder Voting.
• Quorum Requirements: shareholders
representing more than 50% of shares
must be present to conduct business.
• Voting Lists: record of stock ownership. 
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Shareholders
 Shareholders’ Meetings.
• Shareholder Voting.
• Cumulative Voting: allows minority
shareholders to get a board member
elected.
• Other Voting Techniques.
–Shareholder Voting Agreements.
–Voting Trusts—Trustee votes the shares.
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Shareholders
 Rights of Shareholders.
• Shareholder Voting: shareholders may
have various rights, depending on the
articles and bylaws:
• Stock Certificates.
• Preemptive Rights: allows each shareholder
to maintain his proportional control.
• Stock Warrants: buy at a stated price.
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Shareholders
 Rights of Shareholders.
• Dividends: distribution of corporate profits
or income ordered by the board.
• Illegal Dividends.
• Directors’ Failure to Declare a Dividend.
• Inspection Rights.
• Transfer of Shares. 
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Shareholders
 Rights of Shareholders.
• Rights on Dissolution.
• Shareholder’s Derivative Suit. Shareholders
sue a third party on behalf of the
corporation, if the Directors fail or refuse to
correct the wrong or injury.
• Shareholders must first ‘make demand’ on
the board which then has 90 days to decide.

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Shareholders
 Rights of Shareholders.
• Shareholder’s Derivative Suit.
• When shareholders bring a derivative suit,
they are doing so in the name of the
company, not individually.
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Shareholders
 Duties and Liabilities of Shareholders.
• Shareholders are generally not liable for
the contracts or torts of the corporation.
• If the corporation fails, shareholders
generally cannot lose more than their
investment. 
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Shareholders
 Duties and Liabilities of Shareholders.
• Watered Stock: worth less than fair
market value. Shareholder is personally
liable for difference.
• Breach of Fiduciary Duty: can occur when
a shareholder has enough shares to control
the corporation.
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Major Business Forms Compared
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Major Business Forms Compared
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