1. Basic Business Law (BPP432/80) 2006 Fall Quarter Instructor: David Oliveiri Week 10: Facilitating Exchange Through Business Association; Corporations – How To Form and Why, Characteristics

2. Agenda Corporations; Nature --; Formation --; Financial Structure

3. Learning Objectives Understand Why People Associate as Corporations Understand How People Associate as Corporations, and Consequences Understand Some Basic Legal Characteristics of Corporate Finance Understand Pros and Cons of the Corporate Form

4. Corporations – As Business Association Option “Evolutionary” Step Beyond Agency, Sole Proprietor, and Partnership Relationships New Participants – Shareholders, Directors, Officers – In Addition to Employees, Creditors,... But … Principles of Contract and Agency Interwoven Deal Point of Risk vs. Control Foremost in Defining Association Relationships S DO XYZ, Inc. XYZ Corp. XYZ, Ltd.

5. Nature of Corporations Private Arrangement -- Not State “Gift” or Grant Legal Entity -- “Person” Separate From S, D, O Creature of the State – “XYZ, Inc., a New York Corporation” – MCBA RMCBA NYBCL… Limited Liability – S, D, O (BUT…Guarantors) Free Transferability of Corporate Shares Perpetual Existence Centralized Management ― S D O As a Person – Sue, Be Sued, Contracts ― XYZ Corp. by: Sally Smith by: Sally Smith its: President its: President As a Citizen – Of State of Incorporation -- Rights, Duties

6. Classification of Corporations Public – Governmental Purposes – E.G. OTB, NYRA, Lotto – vs. Private For Profit vs. Nonprofit (Not-for-Profit) Domestic vs. Foreign Corporation –Certificate of Authority – “Doing Business” –Sanctions –“Appointing a registered agent is more than a statutory requirement. It’s also an essential business relationship that helps your company avoid default judgments and remain in good standing.” – CT Corporation web site Publicly Held vs. Closely Held Subchapter S Corporation [S&R 34 – Problems 9, 10]

7. Assembles CapitalAssembles Capital Opens AccountsOpens Accounts BorrowsBorrows SALLY SMITH “AskSimon” TOMANN SpreadsheetsSpreadsheets PhonePhone ManualManual Hourly WageHourly Wage Sales Force ConsultingSales Force Consulting “Simon Associates”“Simon Associates” CustomersCustomers SuppliersSuppliers CreditorsCreditors “Bystanders”“Bystanders” “Colleagues”“Colleagues” “Simon Associates Business Software”“Simon Associates Business Software” Big MarketBig Market $ Required$ Required New Relationships?New Relationships? New Risk/Control IssuesNew Risk/Control Issues

8. Forming a Corporation ― Initial Dealings Sally – Gets Idea, Talks Others Into It, Lines Up Initial Investors, Goes To Attorney, Makes Some Decisions “Promoters” – Contract Liability and Duties Subscribers – Contract Liability and Duties Selection of State for Incorporation [S&R 34 – Problems 4, 12]

9. Promoter’s Preincorporation Contracts Corporation Third Party Promoter bound Corporation Does NOT Adopt Preincorporation Contract Promoter Third Party bound Corporation Does Adopt Preincorporation Contract liable Corporation Corporation, Promoter, and Third Party Enter into a Novation Promoter Third Party bound Corporation [S&R 34 – Problem 2] Example: On Behalf of “Corporation to be Formed” Example: On Behalf of “Corporation to be Formed”

10. Review of Sally’s Situation Sally/Tom/Ann – “Simon Associates” “Simon Associates Business Software” Opportunity Need Funding Limited Liability Considerations Decision to Form “Simon Associates, Inc.” Deal Points (Sally, Tom, Ann, Investors) –Contributions –Who Directs/ Voting Rights –Deadlock/Dissolution Sally is Promoter Sally Consults Attorney, Decides to Form Corp. in Nevada

11. Formalities/Mechanics of Incorporation Attorney Phones CT Corp. – “Clear Name/ Send Copies of Nevada Forms” Fill Out Tax/Agent Forms, Articles of Incorporation (Charter) Send to Nevada Secretary of State (Filing Fee) Articles (Charter) Accepted for Filing/Stamped/Returned Meanwhile, Draft By-Laws 1 st Organizational Meeting – Adopt By-Laws, Elect Directors, Subchapter S Consideration Elapsed Time: 1 Day! Elapsed Time: 1 Day!

12. Sample Articles of Incorporation (Charter) Articles of Incorporation of [Corporate Name] The undersigned, acting as incorporator(s) of a corporation under the _____________ Business Corporation Act, adopt(s) the following Articles of Incorporation for such corporation: First: The name of the Corporation is _________________________________________________________________________ Second: The period of its duration is __________________________________________________________________________ Third: The purpose or purposes for which the corporation is organized are:____________________________________________ Fourth: The aggregate number of shares which the corporation shall have authority to issue is _________________________________________ Fifth: Provisions granting preemptive rights are:_________________________________________________________________ Sixth: Provisions for the regulation of the internal affairs of the corporation are:________________________________________ Seventh: The address of the initial registered office of the corporation is ________________________and the name of its initial registered agent at such address is_____________________________________________________________________________ Eighth: The number of directors constituting the initial board of directors of the corporation is __________, and the names and addresses of the persons who are to serve as directors until the first annual meeting of share holders or until their successors are elected and shall qualify are: NameAddress _________________________________________ _________________________________________________ Ninth: The name and address of each incorporator is: NameAddress _________________________________________ _________________________________________________ Dated __________, 19___. _________________________________________________ Incorporator(s) Source: Reprinted with permission from Henn & Alexander, Corporations, 3rd ed. Copyright  1983 by West Publishing Company.

13. Comparison of Charter & Bylaws Smith & Roberson’s Business Law Chapter 34 §

14. What If A Mistake Is Made In Forming? Non-recognition of CorporatenessRecognition of Corporateness RMBCA Approach No Filing of Articles of Incorporation No corporate attributes Joint and several liability for those who act knowing that there was no incorporation Filing of Articles of Incorporation Corporate attributes Limited liability Insulation from collateral suits MBCA Approach No Certificate Issued No corporate attributes Joint and several liability for all who assume to act as a corporation Certificate Issued Corporate attributes Limited liability Insulation from collateral suits RMBCA Evolution – Favors Intent Over Formality!RMBCA Evolution – Favors Intent Over Formality! Distinction Between Filing and IssueDistinction Between Filing and Issue

15. If We Incorporate Correctly Are We Guaranteed Limited Liability? NOT ALWAYS! – “Piercing the Corporate Veil” –PCV is Exception to Limited Liability –Murky Law – Based on Facts and Circumstances –General Rule: Disregard if separateness/ formality gives rise to injustice Suspicious Circumstances – Undercapitalization, Mixing Funds/Assets, Alter Ego Theory –Closely Held Corporations –Parent-Subsidiary Corporations [S&R 34 – Problem 14]

16. Once Incorporated, What Can A Corporation Legally Do Or Not Do? Sources of Corporate Powers Corporation Statutes of State of Incorporation Express Charter Powers – “Power to do such other things as reasonable and proper to conduct business specified.” Implied Powers [S&R 34 – Problem 8] [S&R 34 – Problem 8] What Corporation Can’t Do -- Ultra Vires Acts Liability for Torts and Crimes Direct Liability Respondeat Superior for Officers, Employee Acts Other Exceptions to Limited Liability – Guarantees, Statutory Liability (Antitrust, SOX, Securities Laws, …)

17. General Partnership, Limited Partnership, Corporation, and Limited Liability Company

18. Financial Structure of Corporations Who – Major Corporate Stakeholders are Debt Holders and Stockholders What – Shares of Stock, Bonds, Notes –Evidenced by Certificates –Effect of Certificates Determined by Statute/Contract Law Why – Stock Certificates, Bond Certificates, etc. are pieces of paper – but they are tangible evidence of an important set of rights, interests, claims against assets in an incorporated business. Differences in the terms of arrangements with stockholders, debt holders, are driven by the way in which the various parties deal re: risk assumed by their investment vs. control bargained for to minimize this risk.

19. Debt Securities – Bonds, Notes What – Source of Capital, No Strict Ownership Interest, Secured by Corporation's Promise to Repay When – Determined by Board of Directors How – CONTRACTS; Terms=Covenants (Conditions) Deal Point – Protect Equity Cushion –Maintenance of Property –Dividend Restrictions –Additional Debt Restrictions –Prohibitions on Mergers –Same Business –…

20. Stock – Equity Securities Authorized But Not Issued Treasury Issued Authorized Outstanding Auth=Issued +ABNIAuth=Issued +ABNI Issued=Treas. +Outs.Issued=Treas. +Outs. Auth.= ArticlesAuth.= Articles Issued= BoardIssued= Board

21. Stock – Equity Securities Why Issue – Raise Capital Why Buy -- Limited Liability, Market, Low Transactions Costs, Management, $... BUT Inactive Who Issues – Board of Directors (Securities Laws) How Much – Articles Who Can Buy – Anyone, Unless … Restricted Stock, Pre- Emptive Rights What Price – Par Value Stock, No Par Stock, Treasury Stock What -- Common Stock, Preferred Stock [S&R 34– Problem 2] [S&R 35 – Problem 4] [S&R 35 – Problem 1]

22. Valid Capital Contributions ― Diverse State Laws KindULPARULPAMBCARMBCA CashYes PropertyYes Services renderedNoYes Promise to contribute cashNoYesNoYes Promise to contribute propertyNoYesNoYes Promise to perform servicesNoYesNoYes

23. Debt and Equity Securities

24. Dividends and Other Distributions Types – Cash, Property, Stock, Liquidating Dividends, … Dividend Payment Issues –Unreasonable Accumulation of Surplus –Tax on Accumulated Earnings –Improper Dividends Legal Restrictions – Can’t Render Corporation Insolvent! –Earned Surplus Test –Surplus Test –Net Assets Test Declarations and Payment –Shareholders’ Right to Compel Dividend –Liability for Improper Dividends and Distributions [S&R 35 – Problem 9]

25. Key Concepts in Legal Restrictions Upon Distributions Net Assets Surplus Liabilities (Liquidation Preferences) Stated Capital (contributed capital*) Capital Surplus (contributed capital in excess of par or stated value*) Earned Surplus (retained earnings*) *Accounting terminology Total Assets

26. Liability for Improper Distributions

27. Bottom Lines; Q&A Corporate Business Associations Are A Popular Form – 5 Million For-Profit US Corporations -- $17 Trillion Revenue Benefits of Corporate Form Include Limited Liability, Transferability of Ownership, Centralized Management, Continuity, Prestige, Client and Investor Perception Costs of Corporate Form Include Required Formalities, Transactions Costs, Extensive Default Rules, Double Tax on Distributed Earnings, Losses Usable by Corporation Evolving Favoritism? –New York Times 7/25/06 – Huge Buyout of Hospital Group [HCA] Highlights Era of Going Private –Increasing Flexibility in LLC’s + Growing Investor Acceptance