Corporate Formation and
Financing
Chapter 32
The Nature and Classification
of Corporations
• A corporation is a creature of statute, an
artificial “person.”
• Corporations can have one or more
shareholders, comprised of natural persons
or other businesses.
The Nature and Classification
of Corporations
• A corporation is a legal “person” and enjoys
the same rights and privileges as a natural
person:
• Access to court systems.
• Constitutional guarantees of free
speech, due process, and freedom from
unreasonable search and seizures.
The Nature and Classification
of Corporations
• Corporate Personnel.
– Responsibility for 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.
The Nature and Classification
of Corporations
• Corporate Personnel.
– Shareholders can sue corporation and be
sued by corporation and bring a derivative
suit on behalf of the corporation in some
instances.
The Nature and Classification
of Corporations
• Limited Liability of Shareholders.
– Generally, shareholders are not personally
liable for corporate acts.
– But in certain situations, the corporate
“veil” of limited liability can be pierced,
holding the shareholders personally liable.
The Nature and Classification
of Corporations
• Corporate Earnings and Taxation.
– Profits can either be kept as retained
earnings or passed on to the shareholders
as dividends.
– Corporate Taxation: can be taxed twice,
first to corporation, then to shareholders
via dividends.
The Nature and Classification
of Corporations
• Torts.
– Under respondeat superior, liability for
torts committed by agents within the
course and scope of their employment
The Nature and Classification
of Corporations
• Criminal Acts.
– A corporation can be liable for criminal
acts, but cannot be imprisoned, only
fined.
– However, under the ‘responsible officer’
doctrine, corporate officers may go to
prison.
The Nature and Classification
of Corporations
• Classification of Corporations.
– Domestic corporation does business
within its state of incorporation.
– Foreign corporation from in X state,
doing business in Z state.
– Alien Corporation: formed in another
country.
The Nature and Classification
of Corporations
• Classification of Corporations.
– Public and Private Corporations.
– Nonprofit Corporations.
– Closely Held Corporations
• Shares held by few shareholders.
• More informal management, similar to
a partnership.
The Nature and Classification
of Corporations
• Classification of Corporations.
– Closely Held Corporations
• Management of Closely Held
Corporations.
• Transfer of Shares.
• Shareholder Agreement to Restrict
Stock Transfers.
The Nature and Classification
of Corporations
• Classification of Corporations.
– Closely Held Corporations
• Misappropriation of Closely Held
Corporation Funds.
The Nature and Classification
of Corporations
• Classification of Corporations.
– “S” Corporations:
• Avoids federal “double taxation” of
regular corporations at the corporate
level.
• Only dividends are taxed to the
shareholders as personal income.
The Nature and Classification
of Corporations
• Classification of Corporations.
– “S” Corporations:
• IRS requirements: Corporation is
domestic, fewer than 100
shareholders, only one class of stock,
no shareholder can be a non-resident
alien.
The Nature and Classification
of Corporations
• Classification of Corporations.
– Benefit Corporations.
• For-profit corporation that seeks to
have a material positive impact on
society, but must comply with certain
statutory requirements.
Corporate Formation
• The process of incorporation generally
involves two steps:
– Preliminary and Promotional Activities;
and
– The Legal Process of Incorporation.
Corporate Formation
• 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.
Corporate Formation
• Promotional Activities.
– Promoter’s Liability: Promoter is
personally liable for preincorporation contracts on behalf of
the corporation, unless 3rd party
agrees to hold future corporation
liable.
Corporate Formation
• Incorporation Procedures.
– Select State of Incorporation.
– Secure the Corporate Name.
Corporate Formation
• 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 State.
Corporate Formation
• First Organizational Meeting.
– After the corporation is “chartered”
(created) it can do business.
– Shareholders should approve the bylaws,
elect directors, hire officers and ratify
(novation) pre-incorporation contracts
and activities.
Corporate Formation
• Improper Incorporation.
– De Jure: substantial statutory
requirements are met; cannot be
attacked by state or 3rd parties.
Corporate Formation
• Improper Incorporation.
– De Facto: statutory requirements not
met, but promoters made good faith
effort to comply with corporate law;
can only be attacked by state.
Corporate Formation
• Corporation by Estoppel.
– If it acts like a corporation, it cannot
avoid liability by claiming that no
corporation exists.
– Applies when a third party contracts
with corporation but not filed articles
of incorporation.
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.
Corporate Powers
• Implied Powers.
– All acts reasonably necessary to
accomplish corporate purposes.
– A corporate officer can bind corporation
in contract in matters connected with the
ordinary business affairs of the enterprise.
Corporate Powers
• Ultra Vires.
– Corporate acts beyond the express or
implied powers of the corporation
– Articles of incorporation now adopt very
broad purposes to prevent lawsuits
against the corporation.
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.
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.
Piercing the Corporate Veil
• Factors a court considers:
– Corporation is formed to evade an
existing legal obligation.
– Statutory formalities are not
followed.
– Commingling of personal and
corporate interests or assets.
Piercing the Corporate Veil
• A Potential Problem for Closely Held
Corporations.
– Separate status must be preserved.
– Commingling of funds.
– No director meetings.
– Shareholder use of corporate property.
Piercing the Corporate Veil
• The Alter-Ego Theory.
– Corporation is “alter ego” of majority
shareholder and personal and corporate
interest are commingled such that the
corporation has no separate identity.
Corporate Financing
Bonds
vs.
Stocks
Debt
Ownership/equity
Fixed ROI
Dividends (variable)
No votes
Vote for Management
Optional
Required
Priority over stock
Paid last
Corporate Financing
• Bonds.
– Issued by business firms and government
at all levels.
– Normally have a maturity date – when
principal is returned to investor.
Corporate Financing
• Bonds.
– Sometimes referred to as fixed-income
securities, because bondholders receive
fixed-dollar interest payments.
– Bond indenture: lending agreement.
Corporate Financing
• Stocks.
– Common Stock: represents true
ownership of a corporation.
• Provides pro-rata (proportional)
ownership interest reflected in voting,
control, earnings and assets.
Corporate Financing
• Stocks.
– Common Stock:
• Investors who assume a residual
financing position (whatever is left
may go to dividends to shareholders).
Corporate Financing
• Stocks.
– Preferred Stock: has preferences over
common stock.
• Cumulative Preferred.
• Participating Preferred.
• Convertible Preferred.
• Redeemable or Callable Preferred.
Corporate Formation and
Financing
Chapter 32