Chapter 29: Corporate Formation, Merger, and Termination © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1 Learning Objectives • What steps are involved in bringing a corporation into existence? • What is the difference between a de jure and a de facto corporation? • In what circumstances might a court disregard the corporate entity (“pierce the veil”) and hold shareholders personally liable? • What are the basic differences between a merger, a consolidation, and a share exchange? • What are the two ways in which a corporation can be voluntarily dissolved? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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). © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3 Corporate Personnel • Board of Directors: manage the big picture, set policy, hire officers. • Officers: manage the day-to-day operations of the corporation. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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). © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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 29.1 Williams v. Stanford. Two minority shareholders prevented one 70% shareholder from transferring of corporate assets after proving abuse and fraud. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12 Corporate Formation and Powers • The process of incorporation generally involves two steps: – Promotional Activities; and – The Legal Process of Incorporation. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13 Incorporation Procedures Promotion File Articles of Incorporation Name Search State Charter © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Subscribers 1st Organizational Meeting 14 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15 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”. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16 Incorporation Process: 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 (and maybe the promoters). © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17 Preparing the Articles of Incorporation • 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24 Ultra Vires Doctrine • 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25 Defects in Formation and 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 26 Corporate Status • De Jure Corporation: substantial statutory requirements are met; cannot be attacked by state or 3rd parties. • De Facto Corporation: statutory requirements not met, but promoters made good faith effort to comply with corporate law;corporate status can only be attacked by state. • Corporation By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27 Corporate Status • Corporation By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. Case 29.2 Brown v. W.P. Media, Inc. 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 29 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? Case 29.3 In re Aqua Clear Technologies, Inc. Court held Discount Water was the “alter ego” of the debtor, ACTI, and Jacobson's had created Discount Water to solely to defraud ACTI’s creditors. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 30 Corporate Financing Bonds vs. Stocks Debt Ownership/equity Fixed ROI Dividends (variable) No votes Vote for Management Optional Required Priority over stock Paid last © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 31 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 32 Stocks • Common Stock: represents true ownership of a corporation. Provides prorata (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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 34 Merger and Consolidation • Corporations can grow and expand by: – Mergers. – Consolidation. – Purchase of another corporation’s assets. – Purchases of a controlling interest in another corporation. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A B A 36 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A B C 37 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 38 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 39 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 40 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 41 Purchase of Assets • 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 42 Potential Liability in Purchases of Assets • General rule: a corporation that purchases the assets of another corporation is not automatically responsible for the liabilities of the selling corporation. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 43 Potential Liability in Purchases of Assets • 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 44 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 45 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 46 Responses to Tender Offers: Defenses © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 47 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 48 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 speciallycalled meeting. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 49 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 50 Involuntary Dissolution • Close corporations: – May be able to be dissolved by one shareholder on the happening of a certain event. – Gives the same power to a shareholder to dissolve as a partner has for a partnership. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 51 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 52 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 53