Corporations Chapter 20

Basics of Corporations A corporation is a creature of statute, an artificial “person.” –Most states follow the Model Business Corporation Act (MBCA) or the RMBCA, that are model corporation laws. The shares (stock) of a corporation are owned by at least one shareholder (stockholder).

Constitutional Rights of Corporations A corporation is an artificial “person” and has constitutional rights to: –Equal protection; –Access to the courts, can sue and be sued; –Right to due process before denial of life, liberty, or property.

Constitutional Rights of Corporations Corporation’s rights (cont’d): –Freedom from unreasonable search and seizure and double jeopardy. –Freedom of speech.

Limited Liability of Shareholders The corporation provides limited liability for stockholders. In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable.

Corporate Taxation Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. Corporate profits are taxed under federal and state law as a separate “person” from its shareholders. Profits from a regular “C” corporations are taxed twice: at the corporate level and at the shareholder level.

Torts and Criminal Acts A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior. Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison.

Corporate Powers A corporation may act and enter into contracts as any natural person, except as limited by: –U.S. Constitution. –State constitutions. –State statutes. –Its own articles of incorporation. –Its own corporate bylaws. –Resolutions by its own board.

Express Corporate Powers The express powers of a corporation are 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.

Implied Powers Corporation has implied powers to: to perform all acts reasonably necessary to accomplish its corporate purposes, e.g.,: Borrow and lend money. Extend credit. Make charitable contributions. –A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise.

Classification Of Corporations Domestic corporation does business in its state of incorporation. Foreign corporation from one state doing business in another state. Alien Corporation: formed in another country doing business in United States.

Corporation Formation The process of incorporation generally involves two steps: –Preliminary and Promotional Activities; and –The Legal Process of Incorporation.

Promoter’s Liabilities Promoter is personally liable for pre- incorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable. After corporate formation, corporation can adopt the pre-incorporation contract and release the promoter by creating a “novation”.

Forming A Corporation (Legal Process) State Chartering: Select state (some states such as Delaware cater to corporations). Articles of Incorporation: primary enabling document filed with the Secretary of State that includes basic information about the corporation. Person(s) who execute the articles are the incorporators.

Forming A Corporation (Legal Process) Choose and reserve a Corporate Name. Name must have the proper suffix: “Corporation,” “Incorporated,” “Company ” or “Limited” or an abbreviation of one of these.

Forming A Corporation (Legal Process) Internal organization and rules governing the corporation: usually included in the bylaws. Registered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3 rd parties.

First Organizational Meeting After the corporation is “chartered” (created) a Certificate of Incorporation is issued by the state and it can do business Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities.

Corporate Financing Bond - A debt security that represents borrowing by the corporation, in accordance with a bond indenture—a contract between the issuing corporation and the bondholder. - Priority right to return of capital - Fixed or variable interest rate

Corporate Financing Common Stock –Shareholder has a proportionate interest in the corporate with regard to voting, earnings, and net assets. –Last to Receive Dividends or Surplus on Dissolution

Corporate Financing Preferred Stock –Shares with priority over common stock for payment of dividends and distribution of assets on dissolution. –May pay fixed dividend –May not have voting rights

Bonds v. Stocks Bonds Stocks DebtOwnership/equity Fixed ROIDividends (variable) No votesVote for Management OptionalRequired Priority over stockPaid last

Board of Directors Every corporation is governed by a board of directors. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. A director can also be a shareholder, especially in closely-held corporations.

Duties of Directors Attend Board Meetings Adopt Policies Authorize Major Actions Supervise Officers & Management Approve Dividends

Role of Corporate Officers Officers serve at the pleasure of the Board of Directors (and are elected by them) but have fiduciary duties to company as well. Run day-to-day operations of the corp. Their employment relationships are generally governed by contract law and employment law. Officers may be terminated for cause.

Duties and Liabilities of Directors and Officers Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: -Duty of Care, and -Duty of Loyalty Failure to follow these duties may subject the officers and directors to personal liability

Duty of Care Directors/officers are expected to act in good faith and the best interests of the corporation. –Make informed and reasonable decisions; –Rely on competent consultants and experts; and –Exercise reasonable supervision.

Duty of Care Directors and officers may be liable for negligent acts that breach the standard of due care: –Crimes and torts committed by them individually and/or those committed by employees under their supervision. –Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation.

Duty of Care A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.

Duty of Loyalty –Loyalty to corporation & shareholders instead of personal interest –Cannot compete with corporation –Cannot usurp corporate opportunities –No conflicts of interest

Conflicts of Interest Full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors.

Business Judgment Rule Immunizes a director or officer from liability from consequences of a business decision that turned sour. Court will not require directors or officers to manage “in hindsight.” As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply.

Shareholders Ownership of shares grants a shareholder an equitable ownership interest in a corporation.Ownership of shares grants a shareholder an equitable ownership interest in a corporation. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors.Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders are generally protected from personally liability by the corporate veil of limited liability.Shareholders are generally protected from personally liability by the corporate veil of limited liability.

Shareholder Liability If the corporation fails, shareholders generally cannot lose more than their investment. Shareholders are generally not liable for the contracts or torts of the corporation. However the corporate veil may be pierced under: -“Alter ego theory” or - “Undercapitalization theory”

Shareholder Powers Shareholder powers include approving all fundamental changes to the corporation: –Amending articles of incorporation or bylaws. –Approval of mergers or acquisition. –Sale of all corporate assets or dissolution. Shareholders also elect and remove the board of directors.

Shareholders Meetings Shareholders’ meetings must occur at least annually. Voting requirements and procedures are: –Quorum of shareholders owning more than 50% of shares must be present to conduct business; –Shareholders may appoint a proxy. Common shareholder entitled to one vote per share (bylaws may prescribe ways to help minority shareholders elect Directors).

Shareholders Meetings For special shareholder meetings: –Notice and time of meetings must be sent in writing to each shareholder within a reasonable time ahead of the meeting. –Notice must state reason for meeting and only deal with this matter.

Shareholders Rights Conduct Shareholders Meetings Vote in Person or by Proxy Vote by Number of Shares Owned Inspection of Books & Records Right to Transfer Shares (unless restricted by agreement) Right to buy newly issued stock (Preemptive Rights) Dividends and Rights on Dissolution

Preemptive Rights Common law concept which is a preference to existing shareholders to purchase a pro- rated share of newly-issued stock within a certain period of time. Provided for in the articles of incorporation. Significant in a close corporation to prevent dilution and loss of control.

Dividends Distribution of corporate profits or income.Distribution of corporate profits or income. Only as ordered by the Board (Shareholder approval is not needed).Only as ordered by the Board (Shareholder approval is not needed). Can be stock, cash, property, stock of other corporations.Can be stock, cash, property, stock of other corporations.

Failure by Directors to Declare Dividend When directors fail to declare a dividend, shareholders can sue. Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Often, profits are retained for expansion, research or upgrades.

Mergers and Consolidations Merger - combination of two or more corporations with one corporation surviving A + B = A Successor assumes all liabilities and obligations of prior corporations

Mergers and Consolidations Consolidation - combination of two or more corporations with new corporation created A + B = C Successor assumes all liabilities and obligations of prior corporations

Purchase of Assets or Stock Purchase of Assets - one corporation buys assets of another corporation No assumption of liabilities by purchaser (unless really a continuation of previous company or a fraud to avoid liability) Selling corporation continues to exist

Purchase of Assets or Stock Purchase of Stock - one corporation or party buys stock of another corporation (tender offer) Control of all assets goes with stock Liabilities remain in corporation Corporation may be held as subsidiary or merged into acquiring corporation

Termination Termination of a corporation consists of two phases: –Dissolution (voluntary or involuntary legal “death” of the corporation); and –Liquidation (assets converted to cash and distributed to creditors and shareholders).

Corporations End of Chapter 20