The Legal Environment of Business – Ch. 20

Corporation
– creature of statute
– artificial being, recognized as a “person” and enjoys many of the same rights/privileges that U.S. citizens do
– existence generally depends on state law
– some under federal law (public)
– can have 1+ owners (shareholders) that may be natural persons or other businesses
– operates under name distinct of owners
Model Business Corporation Act (MBCA)
– codification of modern corporation law that has been influential in shaping state corporation statutes.
– most state statutes governed by RMMCA (revised)
Corporate Personnel
– board of directors
– shareholders/owners
– corporate officers
– employees
Board of Directors
– entrusted to overall mgmt. of corp.
– elected by shareholders
– makes policy decisions
– hires corporate officers and employees
Shareholders
– owners of a corp.
– when someone purchases a share of stock in a corp. they become this
– can change constantly w/o affecting the existence of corp
– can sue corp., can sue on behalf of corp., and be sued by corp.
The Limited Liability of Shareholders
– key advantage: limited liability
– normally not personally liable beyond investments
– in some cases, court can “pierce the corporate veil” and impose liability on shareholders
Corporate Earnings and Taxation
– Corporation can decide to pass profits on to shareholders in the form of dividends or retain them (retained earnings)
Retained Earnings of a Corp.
– if invested properly, will yield higher corporate profits in the future, driving up the price of stock.
– shareholders can reap benefits in capital gains they receive when they sell their stock
Corporate Taxation
– profits are subject to income tax by various levels of gov’t
– failure to pay can lead to status suspension or dissolution
– profits can be subject to “double taxation” when company pays taxes, and then shareholders pay taxes on dividends (major disadvantage of corps)
Holding Company
– aka parent company
– company whose business activity consists of holding shares in another company, usually established in a low-tax or no-tax jurisdiction
– used to reduce or defer their U.S. income taxes
– once profits are brought “onshore” they are taxable at the full U.S. rates
Tort Liability of Corporations
– liable for torns committed by agents or officers within the course and scope of their employment
– respondeat superior
Criminal Acts
– corporations may be held liable for the criminal acts of its agents and employees, provided punishment can be applied to corp (fines)
Classification of Corporations
– depends on location, purpose, and ownership characteristics
– Domestic, Foreign, and Alien
– Public and Private
– Nonprofit
– Close
– S
– Professional
– Benefit
Domestic, Foreign, and Alien Corporations
Domestic: referred to by its home state
Foreign: formed in one state but doing business in another is referred to as this by the second state
Alien: formed in another country, but doing business in the US
– do not have automatic right to do business in a different state, sometimes must obtain certificate of authority
– state statues specify what “doing business” entails
Public and Private Corporations
Public: formed by the gov’t to meet a political or governmental purpose. Not the same as a…
Publicly held corporation (public company): shares are publicly traded in a securities market [stock exchange]
Private: created either wholly or in part for private benefit (profit). Most corps are private
Nonprofit Corporations
– aka not-for-profit
– Formed for purposes other than profit
Close Corporations
– most corp enterprises fall into this category (aka closely held, family, or privately held)
– shares are held by members of a family or by relatively few persons generally known to each other
– no trading market for the shares
– often operated like a partnership
– given significant flexibility in rules of operation by RMBCA
– if all shareholders agree in writing, can operate w/o directors, bylaws, annual or special shareholders’ or directors’ meetings, stock certificates, or formal records of decisions
Management of Close Corporations
– resembles sole proprietorship or partnership
– single or tightly knit group of shareholders usually hold positions of directors and officers
– must meet all specific legal requirements set by statutes
– may require more than a simple majority of directors to approve an action to prevent a majority shareholder from dominating the company
Transfer of Shares in Close Corporations
– has small # of shareholders by definition, so transferring shares to someone else can cause problems
Shareholder Agreement in Close Corporations
– to restrict stock transfers
– can provide for proportional control when 1 dies
– may agree that existing shareholders will have an option to purchase stock before it is sold or transferred to an outside party
Misappropriation of Close Corporation Funds
– normal remedy for injured minority shareholders is to have their shares appraised and to be paid the fair market value for them
S Corporations
– a corporation that meets qualifying requirements specified in the Subchapter S of the Internal Revenue Code can choose to operate as this
Most Important Requirements of an S Corporation
1. Must be domestic
2. Must not be a member of an affiliated group of corps
3. Shareholders must be individuals, estates, or certain trusts and tax-exempt organizations
4. Must have no more than one hundred shareholders
5. Must have only one class of stock, although all shareholders do not need to have the same voting rights
6. No shareholder may be a non-resident alien
Effect of S Election
– treated differently for tax purposes
– taxed like a partnership (pass-through)
– shareholder tax bracket may be lower
– allows shareholders to use losses to offset other income
– has lost appeal because LLPs and LLCs offer greater flexibility
Professional Corporations
– typically identified with P.C., S.C. (service corporation), or P.A. (professional association)
– generally normal corporation laws apply
– for liability purposes, some courts treat P.C.s somewhat like partnerships and hold each professional liable for malpractice
Benefit Corporations
– for-profit corporation that seeks to have a material positive impact on society and the environment
Differ from traditional corps in these ways:
1. Purpose
2. Accountability-shareholders aslo have a right of private action enabling them to sue the corporation (benefit enforcement proceeding)
3. Transparency – must issue an annual benefit report published to a public Website
Corporate Formation
– is much simpler today than it used to be
– can be done on the internet
– used to need to take preliminary steps to organize and promote the business prior to incorporating
– no longer need promotional preliminary activities, but should understand personal liability for all pre incorporation contracts
Incorporation Procedures
1. Select a state of incorporation
2. Secure the corporate name (must include: Corp., Inc., Co. or Ltd.
3. Prepare articles of incorporation
4. File AOI w/ secretary of state
– once stamped “Filed” and a returned copy sent to the incorporators, corp. officially exists
Preparing Articles of Incorporation
– include basic info about the corp. and serve as a primary source of authority. Must include:
– those who sign are incorporators.
– varies widely based on jurisdiction, size, and type
– frequently do not provide bylaws
Articles of Incorporation must include…
1. The name of corp.
2. The # of shares the corp is authorized to issue
3. The name and street address of the corp’s initial registered agent and registered office (agent can receive legal documents on behalf of corp.)
4. The name and address of each incorporator (need not have any interest in corp)
Duration and Purpose of a Corp.
– Corporation has perpetual existence unless stated otherwise
– RMBCA does not require a specific statement of purpose to be included in the articles (must be lawful)
Internal Management of a Corp.
– articles can describe this, but is usually included in bylaws adopted after corp. is formed
Bylaws
– internal rules of management adopted by the corporation at its 1st organizational meeting
– typically: voting requirements, election of BODs, methods of replacing directors.
– cannot conflict w/ incorporation statue or articles
– RMBCA-shareholders may amend or repeal and usually the BOD may do so also
1st Organizational Meeting
– must be held after incorporation
– most important purpose is to adopt bylaws
Improper Incorporation
– others may be able to challenge existence of corp if specific procedures were not followed
De Jure Corporations
– rightful and lawful existence
– minor defects are generally overlooked by courts
De Facto Corporations
– when defect in formation is substantial
– outcome will vary based on jurisdiction and whether or not they still recognize the common law doctrine of de facto corporation
Common Law doctrine of de facto corporation
– states that recognize this treat corporations as legal despite defects in formation if 2 requirements are met:
1. A state statute exists under which the corp. can be validly incorporated
2. The parties have made a good faith attempt to comply with the statute.
3. Parties have already undertaken to do business as a corp.
– many states under their version of RMBCA have abolished the common law doctrine
Corporation by Estoppel
– when a business associate holds itself out to others as being a corp when it has made no attempt to incorporate
– will normally be estopped from denying corp. status in a lawsuit
– corp. status does not extend beyond the resolution of problem at hand
Corporate Powers (Express)
– express powers: found in AOI, law of state of incorp., in state and federal constitutions, bylaws. If conflict arises, the following order of priority is used:
1. The U.S. Constitution
2. State Constitutions
3. State Statutes
4. The articles of incorporation
5. Bylaws
6. Resolutions of the BOD
Corporate Powers (Implied)
– arise upon creation
– in absence of express power, corps have implied power to perform acts reasonable necessary to purposes
– to borrow funds, corp acts through BOD usually
Ultra Vires Doctrine
– acts “beyond the power” are ultra vires acts
– has declined in importance
– usually involve nonprofit corporations or municipal (public) corporations
– remedies: shareholders can seek an injection to prevent or stop ultra fires acts or seek damages from those responsible
Piercing the Corporate Veil
– When courts ignore corporate structure and expose shareholders to personal liability
– usually used when corp. privilege is abused
Factors that Lead Courts to Pierce the Corporate Veil
1. A party is tricked or misled into dealing with corp.
2. Corp is set up to never make a profit, always to be insolvent, or is too “thinly” capitalized.
3. Corp is formed to evade an existing legal obligation
4. Statutory corporate formalities are not followed
5. Personal and corporate interests are commingled
Potential Problems for Close Corporations
– nature of corp invites trouble for 1-person or family-owned corp.
1. The commingling of corporate and personal funds
2. Failure to hold BODs’ meetings and record minutes
3. Shareholders’ continuous use of corp property
The Alter-Ego Theory
– sometimes courts pierce the corporate veil under this theory
– applied when a copy is so dominated and controlled by an individual or group that the separate identities of the person and the corp are no longer distinct.
– used to avoid injustice or fraud
Directors and Officers
– BOD is the ultimate authority in every corp. and selects and removes corporate officers, determines capital structure, and declares dividends
– Each BOD has one vote (usually majority rules)
– They are NOT trustees
Election of Directors
– # set forth in AOI or bylaws
– either appointed by rise BOD at time of corp creation, or named in AOI
– usually serves 1 year (meeting to meeting)
Removal of Directors
– can occur for cause (for failing to perform a required duty by AOI or shareholder action
Vacancies on Board
– if director dies or resigns or when new positions created
– shareholders or board can fill position
Compensation of Directors
– Directors are often paid at least nominal sums
– RMBCA allows BOD to set their own compensation unless AOI or bylaws prohibit
Inside Director
– a director who is also an officer
Outside Director
– a director who does not hold a management position
BOD Meetings
– dates established in AOI or bylaws or board resolution
– recorded minutes
Quorum of Directors
– BOD normally constitute a quorum
– minimum number of member of a body of officials or other group that must be present for business to be validly transacted (unless specified a greater number by AOI or bylaws)
Committees of BOD
– two common types:
1. executive committee – interim mgmt. decisions
2. audit committee – selection, compensation and oversight of the independent public accountants
Rights of Directors
1. Right to Participation
2. Right of Inspection -cannot be limited by AOI or bylaws
3. Right to Indemnification (reimbursement)
Corporate Officers and Executives
– hired by BOD
– most have a president, vp(s), a secretary, and a treasurer.
– are agents of the corp. and rights are defined by employment contracts.