MGMT 224 – CLASSES 9 & 10
CORPORATIONS - 2011
I. CORPORATIONS : HISTORY & TYPES
A. BACKGROUND:
1. At first, corporations only allowed by specific legislative charter.
2. Then states started passing General Incorporation Laws, setting forth
conditions for any company to incorporate.
3. Some states tried to attract corporations, by passing favorable laws:
a. New Jersey: Turn of the century
b. Upstaged in 20th Century by Delaware. They now have some 40 50 % of the largest national corporations.
4. MBCA: Model Business Corporation Act (passed in about half of the
states): sets “suggested laws” for states to follow
5. Two main aspects of Corporation:
a. Limited Liability
b. Perpetual existence
B. FORMATION OF CORPORATION: ADVANTAGES & DISADVANTAGES
1. Advantages:
a. Limited Liability:
b. Perpetual Existence: People can die, retire, or leave, and the
corporation can go on. Ownership interest is easily transferred
without necessity of dissolution.
c. Tax Advantages: Deductions: Certain deductions are allowed not
allowed to individuals: e.g. life insurance for officers, more liberal
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pension plans, etc. Others, such as cars & entertainment expenses
are easier & more legitimately passed through a corporation.
2. Disadvantages:
a. Taxes: Double taxation, no flow through of losses
b. Formalities: Meetings, minutes, two sets of books, etc.
c. Expenses: Accounting, legal & filing fees; minimum taxes, even if you
don't make income (CALIFORNIA: Cost = $ 115.00 to start)
3. Subchapter S: Minimize the disadvantage of double taxation.
a. Subchapter S of the Internal Revenue Code
b. Restrictions:
(1) 100 or fewer SH’s
(2) One class of stock
(3) No foreign SH’s
(4) No entity SH’s [like corporations or LLC’s]
c. Requirements:
(1) 100% SH approval.
(2) Filing of “S” election by March 15th (2.5 mos. into tax year)
d. Termination…
(1) Voluntary: > 50% SH vote
(2) Involuntary:
(a) Restriction is violated (e.g. 101st SH accepted)
--or-2
(b) Excess Passive Income (25% or more), if formerly a C
corporation
(3) If terminated – must stay a “C” corporation for at least 5 years
before an S election can be filed.
4. Closed or Exempt Corporations:
a. Statutes allowing SH to exercise more direct control and avoid
corporate norms --- authorize Close Corporations.
b. CALIFORNIA: Subject to the following restrictions…
(1) One class of stock
(2) 35 SH’s or less
(3) No promotion - No advertising, solicitation, etc.
(4) Legal consideration - usually only money or property
(except if only H & W -- any legal consideration)
5. Professional Corporations:
a. Advantages: Same as regular coproration.
b. Liability limited as to commercial creditors but not professional
liability (malpractice).
c. Shareholders and key directors must be professionally
licensed, and corporation registered with state licensing
agency.
C. INCORPORATION:
1. Where: State of one's choice...
a. If ABC, Inc. files articles in CA and does 99% of its business in AZ. In
which state is it a domestic corporation, and in which is it a foreign
corporation?
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(1) Arizona: Foreign
(2) California: Domestic
b. Can California require qualification of a foreign corporation that does
business in this state? YES
c. Can they tax it? YES
d. Runaway Corporation (or Pseudo Corporation) Laws: California and
some states impose certain SH voting rules on foreign corporations
where…
(1) Corporation does >50% of business, has >50% of assets and
has >50% of SH’s in California.
(2) Supreme Court has upheld this power.
2. Incorporators/Promoters:
a. They get the show going -- and usually get reimbursed by the
corporation. BUT -- usually only if the corporation agrees.
b. Pre-incorporation contracts: Will promoter remain liable? Will corp.
become liable?
(1) Liability of Promoter:
contracts, unless:
Promoter remains liable on these
(a) Released by Creditor (in original agreement or later)
--OR-(b) NOVATION – between Creditor and newly formed
corporation.
(2) Liability of corporation:
contracts, unless…
Corporation is not liable on pre-inc.
(a) NOVATION (as above)
--OR-(b) Adoption – Corporation approves the contract expressly
(by resolution) or impliedly (by accepting the benefits).
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II. FORMATION : What happens...
A. Formation Process::
1. Articles of Incorporation:
(1) Once you file this 1 page form and pay fee, you have established
a valid corporation.
(2) Contents of Articles required in CALIFORNIA:
 Name of Corporation
 Name of Agent & Incorporator
 Number of authorized shares (max. that can be sold)
 Purpose (general or specific)
2. Other formalities: First or Organizational Meeting:
a. Incorporator designates directors & resigns
b. Directors comply with 3 mandatory provisions:
 Adopt By-Laws
 Select Officers
 Issue shares
c. Minutes (record of the meeting)
NOTE: Difference between a Board of Directors and officer:
(i) Director: Set policy and govern the corporation on behalf
of the shareholders. Do things like amending the by-laws,
declaring dividends, etc.
(ii) Officers: Pres., VP, Sec. & Treas. (CEO or CFO) elected
to run the day-to-day operations of the company. They are
usually salaried employees of the corp.
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B. FAILURE TO COMPLY WITH INCORPORATION REQUIREMENTS:
1. Piercing the corporate veil: SH’s lose their protection from liability if
a third party can establish any one of the following:
a. Undercapitalization of the company.
b. Formalities or separateness ignored
c. Commingling of corporate/personal assets
2. SH Defense: Corporation de Jure: Substantial compliance with state
corporation's laws (all “mandatory provisions”) - e.g. articles, shares
issued, etc. Law will forgive minor errors in formalities.
3. SH Defense: Corporation de facto:
Even if no substantial
compliance, if promoters made a good faith attempt to incorporate &
business is conducted as a corporation, their existence may not be
questioned (so long as SH’s are unaware of the defect in formation).
III. CORPORATIONS - Financing & Stock Issuance
A. FINANCING THE CORPORATION: Issue “Securities” : Two kinds
1. Debt Financing:
a. Examples:
(1) Bonds: Secured long term promissory obligation (usually at a
prescribed maturity date), with interest
(2) Debentures: Unsecured obligation – usually long term also.
(3) Notes: Loans with fixed interest and repayment plan (usually
sooner than bonds)
b. Main features of debt securities:
(1) Fixed rate of return.
(2) Return is not tied to corporate profits
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(3) No voting power, however
2. Equity Financing: More common ---the classic sale of shares or stock.
a. Main Features: Variable return, tied to corporate profits, voting
power.
b. Kinds of consideration allowed:
(1) In all States (including California & Delaware):
 Money
 Property
 Past Services
(2) Delaware & some states (NOT in California):
 Future Services
 Promissory Note
B. TERMINOLOGY:
1. If the Articles of Incorporation provide for 10,000 shares of stock. Ms.
YYY pays & gets 2500, Mr. XXX gets 2500, and Ms. ZZZ gets 2500.
Then, Ms. ZZZ decides to leave and corporation buys back her
shares. What are the number of...
a. Authorized shares: 10,000
b. Issued shares: 7,500
c. Outstanding: 5,000
2. Classes of Shares:
a. Common: Most common. This is "voting stock".
(1) Exclusive right to elect Board of Directors
(2) Claims are subordinate to creditors & other class SH
(3) BUT they have exclusive claim to corporate earnings
and assets that exceed the claims of creditors/others
class SH
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b. Preferred: Usually have priorities in receiving dividends & upon
dissolution – but limited voting power.
(1) Cumulative: Unpaid dividends accumulate from year to year
(2) Non-Cumulative: End of year = end of dividend.
(3) Participating: Share with Common SH’s in additional profits.
(4) Non-Participating: Are entitled to the established preferred
dividend and nothing more.
3. Two kinds of valuation:
a. Par Value: Price is stated in Articles & Share Certificates.
Shares cannot be issued for less than this amount of
consideration (results in “watered stock” if they are)
b. No Par Value: No stated value. No “minimum” value required
for issuance.
c. Penny Stock: Some corporations will establish 1 cent value to
avoid problems where Par Value < FMV.
d. California: No Par Value state
IV. CORPORATE GOVERNANCE:
A. Players:
1. Shareholders: Owners & controllers (in theory), they elect the Directors.
2. Directors: They set corporate policy, make the important overall decisions.
3. Officers: Implement director's policy; run the day-to- day operations.
B. SHAREHOLDERS:
1. POWERS:
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a. Election and Removal of Directors:
(1) Done at annual SH meetings
(2) Removal: Common Law, can only be done "for cause"
(3) Modern Rule (MBCA & CAL): Can be removed by majority vote of
shareholders, unless Articles prohibit or designate only certain class
of shares can elect (and therefore remove)
(4) Judicial Removal: In CA, can be removed by judicial action brought
by 10% or more of shares owned for such things as:
(a) Fraud or dishonesty
(b) Gross abuse of authority/discretion
b. Adoption, Repeal & Amendment of Bylaws:
(1) What governs a corporation?
(a) Articles: (Like constitution)
(b) By-Laws: Like statutes
(c) Resolutions: Like regulations
(d) Minutes: Summary of meetings, elections, &recording of events.
(2) By Laws: Those regulations which corp. empowered to make for...
(a) Its internal government
(b) Management of its property
(c) Regulation of its affairs
(d) Transfer of its shares of stock
(3) Who has the power to amend, repeal or adopt:
---Incorporators
---Shareholders
---Directors
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c. Voting Extraordinary Corporate Changes (“the Big 4”):
(1) Amending Articles
(2) Mergers & Consolidations
(3) Transfer of major corp. assets
(4) Dissolution
NOTE: The Big 4 also require approval by Directors.
2. SHAREHOLDER MEETINGS: Requirements…for SH action:
a. SH Powers must be exercised at a Meeting:
(1) Annual Meetings: Required by all states. Any SH can demand.
(2) Special Meetings: Can be called by Bd. or Officers, or, as in CA, by
holders of 10% or more of the voting shares.
b. Requirements of Legal Meeting:
(1) Notice (or waiver) to all SH’s
(2) Quorum:
(a) 50% + 1 share
(b) By-Laws can establish a lower quorum, but no < 1/3
(3) Majority vote of Shares present = SH action.
(4) SH’s can vote by proxy…
(a) Written Authorization to vote.
(b) Revocable unless stated.
(c) Valid for 11 months
(5) Voting agreements also valid.
V. CORPORATE GOVERNANCE - EXECUTIVES (Directors & Officers)
A. Powers of Directors:
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1. Extraordinary Corporate Changes – the Big 4 (both SH’s and Directors
must approve)
a.
b.
c.
d.
Mergers, etc.
Dissolution
Sale of Major Assets
Amending Articles of By Laws
2. Elect/remove Officers (no cause needed)
3. Declare/Pay Dividends to SH’s
a. Must be affordable by the corporation under either the Balance
Sheet Test or the Solvency Test.
b. Cannot be unreasonably withheld (see DODGE case)
4. Issue Shares to new Shareholders
5. Amend/Adopt By-Laws
B. DUTIES of Executives
1. Apply to Directors and Officers
2. They are fiduciaries: Vested with a special form of trust, who are required
to act in good faith towards not only the shareholders but the corporation.
C. Duty of Care: Act as a reasonable director/officer would.
1. Business Judgment Rule: Executive's negligent decision OK, so long as:
a. Informed decision
b. Rational basis
c. No conflicts
2. Corporate Consituency Statutes: Directors are allowed to consider the
effects corporate decisions will have on “other constituencies” (e.g. the community,
customers, society, etc.)
D. DUTY OF LOYALTY: Most common theory vs. execs.
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1. Same as Agent's duty to principal. Three basic areas to avoid:
a. Self Dealing - Includes insider trading, competing with corporation, etc.
b. Common Directorships: Director serves on >1 corporate board.
c. Corporate Opportunities: SH buys corporate opportunity
2. Self Dealing: Exec deals with Corp. Self dealing is OK -- so long as its to
benefit corporation. Requires the following....
(Both the majority rule & CALIF)
a. Disclosure of material facts to SH.
b. Refrains from voting on corp. approval
c. One of the following…
(1) Approved by SH, exclusive of director's vote.
(2) Approved by BOD, "
"
"
".
(3) Fair & just deal for the corporation
3. Common or Interlocking Directorships: SAME STANDARDS.
4. Corporate Opportunities:
a. The doctrine allows a corporation to claim for itself all benefits obtained
by its execs. for their personal gain from any business opportunities in the
corporation`s line of activities.
b. Must be a corporate opportunity:
(1) The opportunity must be in the corporation's line of business
or activities.
--AND-(2) Must be one that the corporation can afford, is within its
purpose, and that it can take advantage of.
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E. RIGHTS OF DIRECTORS:
1. INDEMNITY: The corporation will indemnify the exec. for damages.
2. PARTICIPATION:
3. INSPECTION
4. COMPENSATION:- set out in By-Laws or resolution
VI. RIGHTS OF SHAREHOLDERS
A. Inspection: Must be with advance notice and for proper purpose.
B. Pre-emptive Rights:
1. Right of first refusal to buy newly issues shares.
2. These rights exist only if set forth in the By-Laws or Articles.
C. Appraisal or Dissenters Rights:
1. Where corporation makes a major business change (e.g. a merger), a
SH can demand to have the corporation buy out his or her shares at
FMV.
2. These rights exist by law unless excluded in By-Laws or Articles.
D. SH Rights can be affected if CORPORATION retains Right of Redemption
(to buy back shares when corporation wishes – converts to Treasury
Stock).
VII. ENFORCEMENT OF DUTIES BY SH:
A. Inspection of Books: Any SH may
1. upon written demand
2. If Proper purpose: Not for private gain or harassment
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B. Lawsuits by Shareholders:
1. Direct Action: Damage or wrong to SH personally (e.g. Pillsbury)
2. Class Action: Where SH wants to include all SH as Plaintiffs.
3. Derivative Suit: This is CALIF. standard.
a. If corporation should be suing a THIRD PARTY (including the directors),
but refuses for some reason, then shareholders can step in and sue on
Corporation’s behalf.
b. Derivative Suite requires the following:
(1) Exhaust corp. remedies: SH’s must demand corporation sue the 3rd
party or directors, unless such demand is futile (e.g. it’s silly for SH to ask the
directors to sue themselves).
(2) Suing SH’s must be in the minority.
(3) Must be record owner of shares at time of suit.
(4) Name Corporation as Defendant: Necessary party
since seeking corporation to act.
(5) Corporation receives damages awarded by the court
(6) So why go through all this trouble in the first place? Because the
SH can't get corp. to act and his interest as owner of corp. is being affected.
VIII. CORPORATE COMBOS
A. Merger: A + B = B or A + B = A
1. Procedure: File Articles of Merger with Secretary of State
2. Requires…Majority vote of SH’s AND Directors
3. One corporation “survives”
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B. Consolidation: A + B = C
1. Procedure: File Articles of Consolidation with Secretary of State
2. Requires…Majority vote of SH’s AND Directors
3. New Corporation formed
C. Acquisition: Can be accomplished by Purchase of Shares or Purchase of
Assets. Where A buys B’s assets…
1. Requires only the vote of SH and Directors of Seller Corp. (B)
2. Liabilities not assumed
D. Stock Exchange: A buys B by giving B’s shareholders stock in A in
exchange for B’s stock.
E. Stock for Assets Exchange: A buys B’s assets by giving B SH’s stock in
A in exchange for B’s assets.
F. Merger, Consolidation, Stock Exchange and Stock for Assets Exchange
are all tax free.
G. Sale of Assets or Sale of Stock will be taxed.
IX. DISSOLUTION: Three basic situations…
A. Voluntary = 50% vote of SH’s
B. Judicial = Brought by minority SH or creditor because corporation is
insolvent or deadlocked.
C. Administrative = State takes away corporate charter because of nonpayment of taxes/fees or other violations of corporate law.
[TIME PERMITTING: THE FOLLOWING PAGES HAVE THE MATERIALS ON CORPORATE
SECURITIES REGULATION]
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X. SECURITIES REGULATION:
A. Overview of the Acts:
1. Securities Act of1933: Focus on Initial Issuances
2. Securities Exchange Act of 1934: Focus on Later Re-Sales
3. Each act also has an Anti Fraud component.
4. It’s two Acts but really four separate laws:
1933  Reporting
 Anti-Fraud
1934  Reporting
 Anti-Fraud
Remember: First in time (1933) deals with the First Issuance
Later in time (1934) deals with Later Resales
C. What is a security?
1. Elements: Investment, In a Group & 3rd Party Will Manage
2. Examples of Securities…
a.
b.
c.
d.
e.
Stocks (equity securities)
Bonds/debentures/notes (debt securities)
Investment contracts
Limited partnership interests
Collateral Trust Certificates
XI. 1933 ACT:
A. What is a First Issuance?
1. First time stock is sold to the public
2. HYPO: IBM issues 3 million to Merrill Lynch on Monday.
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--- First Issuance? NO
3. It’s really the first sale to “the little guy” (general public)
4. Who is NOT THE GENERAL PUBLIC:




Brokers/Dealers
Directors of Corp.
Officers of Corp.
SH owning > 10% (Insider)
}
} These folks know what’s
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B. REPORTING REQUIREMENTS:
----|----------------------|-----------------------|---------------------------|---Registration
tombstone ad
red herring SEC
Statement <-------------------- 20 days ----------------------> Approval
1. Registration Statement: Big ole document in two parts:
a. Part One: Prospectus (any written offer to sell securities)
b. Part Two: Information About the Investment, including…
 Audited financials
 Insider info. (directors, officers, 10%+ SH’s, attorney, CPA)
 Business purpose
 Capital structure
 If they ask, pick “d” – all of the above. 
c. Shelf Registrations allowed for big companies.
2. Twenty Day Waiting Period: SEC has 20 days to approve
a. During this time, can’t offer to sell nor sell securities.
b. However, issuer CAN announce the opportunity by way of
STOP.
S – Summary Prospectus (small companies)
T – Tombstone Ad – contains brief info of upcoming
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opportunity
O – Oral Offers are ok.
P –Preliminary Prospectus : Red Ink warning
sometimes this is called a Red Herring
3. Approval: As to form, not content – SEC merely verifies the required
information is there, not that it’s right. Failure to respond in 20 days
= SEC approval.
NOTE: WRONG ANSWERS on Exam:
 SEC approval means it’s a wise investment
 SEC approval means all the info. is correct.
4. Prospectus: After approval, issuer can issue Prospectus and
advertise opportunity/solicit buyers.
5. Blue Sky Laws: State have their own rules which must also be
complied with (whether or not SEC qualified or exempt issuance).
C. EXEMPTIONS: Registration N/A if offer/sale EXEMPT:
1. Exempt Securities: Never, Ever have to Register (5 categories)
If your are clean, your securities are exempt. You are clean if you:
S – Stock splits, stock dividends, stock exchanges (FREE)
C – Charities
R – Railroads
U – Units of Government
B – Banks
2. Exempt Transactions: Four Basic Areas…(SEE THE CHART)
a. Intrastate: Sale of securities exclusively withing a
state, with no re-sale to non-residents
within 9 months – Otherwise, no limitations!
b. Small Private: Reg D, Rule 504: Up to $ 1,000,000 (pvt.)
This amount is considered pidly now (law changed).
So, also no restrictions!!
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c. Large Private: TWO TYPES: Limited (Reg D, Rule 505) and
Unlimited (Reg D, Rule 506):
 505: $ 5,000,000 MAX
 506: Unlimited
For both of these Restricted Advertising and
Restricted Resale
Also, limited to 35 Non-Accredited investors
(Accredited = sophisticated Fat Cats)
(Non-Accredited = poor stupid people)
Finally, extensive disclosures – audited bal. sheets
d. Small Offering: Reg A: Up to $ 5,000,000 (pvt. or public)
This may be private or public, so more info. required.
Some disclosure req’d (circular–few years financials)
3. Exam will try to sucker you in with 35 investor rule….
remember its nonaccredited only and it only
applies to Large Private (more than $ 1,000,000)
4. Can I just sell $ 999,999 every Monday? NO - All issuances within
12 month period counted as 1 issuance.
5. Regulation D: Must notify SEC within 15 days of first sale.
6. Remember “D” is for Detective, a Private Detective.
D. ANTI-FRAUD PROVISIONS: Thou shalt not ever lie, cheat, mislead, etc.
in the issuance/sale of securities. ALL TRANSACTIONS are covered here, no
matter how small or to whom made.
XII. 1934 ACT:
A. Requires reports from certain “widely traded” companies….
1. Traded on National Stock Exchange
- OR -
2. >$ 10,000,000 in assets and 500+ stockholders
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B. Reports Required by corporation (issuer) AND by insiders themselves.
1. 10K – Annual Report: Includes audited financial statements
2. 10Q – Periodic Reports: Remember Q = Quarterly (UNAUDITED)
3. 8K – Updates: Within 15 days of major changes between reports.
C. Requires Proxy Solicitations to be filed with SEC & contain disclosures.
D. Tender Offers: Takeover offer
1. Required when buyer owns 5% or will own 5% from the tender offer
2. Certain disclosures: Disclose funding, stock ownership & future plan
to SH’s solicited and to the SEC.
E. 10(b)5: Anti Fraud provisions requires reporting of insider trading and
return to the company of short swing profits.
1. Insider Trading: Buy/sell by 10%+ SH, directors, officers,
attorneys,etc.
-- It is not illegal for insider to buy/sell, but it is illegal to use
secret information
2. Short Swing Profits: By insider, w/in 6 month period, must return to
Corporation.
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