Business Law and the Regulation of Business Chapter 34: Nature and Formation of Corporations By Richard A. Mann & Barry S. Roberts

Topics Covered in this Chapter I. Nature of Corporations A. Corporate Attributes B. Classification of Corporations II. Formation of a Corporation A. Organizing the Corporation B. Formalities of Incorporation III. Recognition or Disregard of Corporateness A. Defective Incorporation B. Piercing the Corporate Veil IV. Corporate Powers A. Sources of Corporate Powers B. Ultra Vires Acts C. Liability for Torts and Crimes

Corporate Attributes n Legal Entity – a corporation is an entity apart from its shareholders, with entirely distinct rights and liabilities. n Creature of the State – a corporation may be formed only by substantial compliance with a State incorporation statute. n Limited Liability – a shareholder's liability is limited to the amount invested in the business enterprise.

Corporate Attributes n Free Transferability of Corporate Shares – unless otherwise specified in the charter. n Perpetual Existence – unless the charter provides otherwise. n Centralized Management – shareholders of a corporation elect the board of directors to manage its business affairs; the board appoints officers to run the day-to-day operations of the business.

Nature of Corporations n As a Person – a corporation is considered a person for some but not all purposes. n As a Citizen – a corporation is considered a citizen for some but not all purposes.

Classification of Corporations n Public Corporation – one created to administer a unit of local civil government or one created by the United States to conduct public business. n Private Corporation – one founded by and composed of private persons for private purposes; has no governmental duties.

Classification of Corporations n Profit Corporation – one founded to operate a business for profit. n Nonprofit Corporation – one whose profits must be used exclusively for charitable, educational, or scientific purposes.

Classification of Corporations n Domestic Corporation – one created under the laws of a given State. n Foreign Corporation – one created under the laws of any other State or jurisdiction; it must obtain a certificate of authority from each State in which it does intrastate business.

Classification of Corporations n Publicly Held Corporation – one whose shares are owned by a large number of people and are widely traded. n Closely Held Corporation – one that is owned by few shareholders and whose shares are not actively traded.

Types of Corporations n Subchapter S Corporation – eligible corporation electing to be taxed as a partnership under the Internal Revenue Code. n Professional Corporations – corporate form under which duly licensed individuals may practice their professions.

Formation of a Corporation n Promoter – person who takes the preliminary steps to organize a corporation –Promoters' Contracts – promoters remain liable on preincorporation contracts made in the name of the corporation unless the contract provides otherwise or unless a novation is effected. –Promoters' Fiduciary Duty – promoters owe a fiduciary duty among themselves and to the corporation, its subscribers, and its initial shareholders.

Promoter’s Preincorporation Contracts Corporation Third Party Promoter Corporation, Promoter, and Third Party Enter into a Novation Promoter Third Party bound Promoter Third Party bound Corporation Does Adopt Preincorporation Contract liable bound Corporation Does NOT Adopt Preincorporation Contract Corporation

Organizing the Corporation n Subscribers – persons who agree to purchase the initial stock in a corporation. –Preincorporation Subscription – an offer to purchase capital stock in a corporation yet to be formed which under many incorporation statutes is irrevocable for a specified time period. –Postincorporation Subscription – a subscription agreement entered into after incorporation; an offer to enter into such a subscription is revocable any time before the corporation accepts it.

Formalities of Incorporation n Selection of Name – the name must clearly designate the entity as a corporation. n Incorporators – the persons who sign the articles of incorporation. n Articles of Incorporation – the charter or basic organizational document of a corporation. n Organizational Meeting – the first meeting, held to adopt the bylaws and appoint officers. n Bylaws – rules governing a corporation's internal management.

Sample Articles of Incorporation 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___. _________________________________________________ Incorprator(s) Source: Reprinted with permission from Henn & Alexander, Corporations, 3rd ed. Copyright  1983 by West Publishing Company.

Defective Incorporation Common Law Approach n Corporation de Jure – one formed in substantial compliance with the incorporation statute and having all corporate attributes. n Corporation de Facto – one not formed in compliance with the statute but recognized for most purposes as a corporation. n Corporation by Estoppel – prevents a person from raising the question of a corporation's existence.

Statutory Approach n The filing or acceptance of the articles of incorporation is generally conclusive proof of proper incorporation. n RMBCA – liability is imposed only on persons who act on behalf of a defectively formed corporation knowing that there was no incorporation. n MBCA – unlimited personal liability is imposed on all persons who act on behalf of a defectively formed corporation.

Recognition of Corporate Attributes: Statutory Approach 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

Piercing the Corporate Veil n General Rule – the courts may disregard the corporate entity when it is used to defeat public convenience, commit a wrongdoing, protect fraud, or circumvent the law. n Application – most frequently applied to –Closely Held Corporations –Parent-Subsidiary Corporations

Sources of Corporate Powers n Statutory Powers – typically include perpetual existence, right to hold property in the corporate name, and all powers necessary or convenient to effect the corporation's purposes. n Purposes – a corporation may be formed for any lawful purposes unless its articles of incorporation state a more limited purpose.

Ultra Vires Acts n Definition of Ultra Vires Acts – any action or contract that goes beyond a corporation's express and implied powers. n Effect of Ultra Vires Acts – under RMBCA, ultra vires acts and conveyances are not invalid. n Remedies for Ultra Vires Acts – the RMBCA provides three possible remedies.

Liability for Torts and Crimes n Torts – under the doctrine of respondeat superior, a corporation is liable for torts committed by its employees within the course of their employment. n Crimes – a corporation may be criminally liable for violations of statutes imposing liability without fault or for an offense perpetrated by a high corporate officer or its board of directors.

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

Comparison of Charter & Bylaws