Chapter 34 Corporate Formation and Financing

Learning Objectives What steps are involved in bringing a corporation into existence? What is the difference between a de jure corporation and a de facto corporation? In what circumstances might a court disregard the corporate entity (pierce the corporate veil) and hold the shareholders personally liable?  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objectives How are corporations financed? What is the difference between stocks and bonds? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification A corporation is a creature of statute, an artificial “person.” Corporations can have one or more shareholders. Owners can be natural persons or other businesses. Corporation substitutes itself for shareholders. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Corporate Personnel. Responsibility for overall 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. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Corporate Personnel (cont’d). Shareholders can sue corporation and be sued by corporation and bring suit for corporation in some instances. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Constitutional Rights of Corporations. Corporation is recognized as a legal “person” and enjoys virtually same rights and privileges under our Constitution as a natural person: Access to court systems. Constitutional guarantees of free speech, due process, and freedom from unreasonable search and seizures. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Limited Liability of Shareholders. One of the key advantages of corporations is the limited liability of owners (shareholders). In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Corporate Earnings and Taxation. Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. Corporate Taxation: corporate taxes can be taxes twice, first to the corporation, then to the shareholders via dividends.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Corporate Earnings and Taxation (cont’d). Holding Companies (parent company): company whose business activity consists of holding shares in another company. Typically holding company is established off-shore (Cayman Islands, Hong Kong, etc). © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Torts and Criminal Acts. 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. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations. Domestic corporation does business in its state of incorporation. Foreign corporation from X state doing business in Z state. Alien Corporation: formed in another country doing business in United States. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations (cont’d). Public and Private Corporations. Nonprofit Corporations. Close Corporations: Shares held by few shareholders. More informal management, similar to a partnership. Restriction on transfer of sale and transfer of shares.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations (cont’d). Close Corporations (cont’d). Management of Closely Held Corporations. Transfer of Shares Shareholder Agreement to Restrict Stock. Misappropriation of Closely Held Corporation Funds.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations (cont’d). Close Corporations (cont’d). Misappropriation of Close Corporation Funds. CASE 34.1 Williams v. Stanford (2008). Was it acceptable for the Williams brothers to demand $125,000 each for their shares? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations (cont’d). “S” Corporations. Avoids federal tax under IRS Code “Subchapter S.” Avoids federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. See requirements (p. 742).  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Nature and Classification Classification of Corporations (cont’d). “S” Corporations: avoids federal tax under IRS Code “Subchapter S.” IRS requirements: Corporation is domestic, fewer than 75 shareholders, only one class of stock, no shareholder can be a non-resident alien. Professional Corporations. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers The process of incorporation generally involves two steps: Preliminary and Promotional Activities; and  The Legal Process of Incorporation. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers 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.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers Promotional Activities (cont’d). Promoter’s Liability: Promoter is personally liable for pre-incorporation contracts on behalf of the corporation, unless 3rd party agrees to hold future corporation liable. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers Incorporation Procedures. Select State of Incorporation. Secure the Corporate Name. 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. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers First Organizational Meeting to Adopt Bylaws. After the corporation is “chartered” (created) it can do business. At meeting, shareholders should approve the bylaws, elect directors, hire officers and ratify pre-incorporation contracts and activities. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers 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. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers Corporate Powers (cont’d). Implied Powers. To perform all acts reasonably necessary to accomplish its corporate purposes. A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Formation and Powers Corporate Powers (cont’d). Ultra Vires Doctrine. Corporate acts beyond the express or implied powers of the corporation (by statute of articles of incorporation). Corporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Defects in Formation and Corporate Status De Jure and De Facto Corporations. De Jure: substantial statutory requirements are met; cannot be attacked by state or 3rd parties. De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law; can only be attacked by state. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Defects in Formation and Corporate Status Corporation by Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. CASE 34.2 Brown v. W.P. Media, Inc. (2009). Why couldn’t W.P. Media deny Alabama MBA’s existence? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Defects in Formation and Corporate Status 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. Factors a court considers: 3rd party tricked into dealing with a corporation rather than the individual.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Defects in Formation and Corporate Status Piercing the Corporate Veil (cont’d). Factors (cont’d): Corporation is set up never to make a profit or remain insolvent or is undercapitalized. Corporation is formed to evade an existing legal obligation. Statutory formalities are not followed.  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Defects in Formation and Corporate Status Piercing the Corporate Veil (cont’d). Factors (cont’d): Commingling of personal and corporate interests or assets. A Potential Problem for Closely Held Corporations. CASE 34.3 Schultz v. General Electric Healthcare Financial Services (2010). Why was Schultz personally liable? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Financing Bonds vs. Stocks Debt Ownership/equity Fixed ROI Dividends (variable) No votes Vote for Management Optional Required Priority over stock Paid last © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Financing Bonds. Issued by business firms and government at all levels. Normally have a maturity date – when principal is returned to investor. Sometimes referred to as fixed-income securities, because bondholders receive fixed-dollar interest payments. Bond indenture: lending agreement. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Financing Stocks. Common Stock: represents true ownership of a corporation. Provides pro-rata (proportional) ownership interest reflected in voting, control, earnings and assets. Investors who assume a residual financing position (whatever is left may go to dividends to shareholders).  © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Financing Stocks (cont’d). Preferred Stock: has preferences over common stock. Cumulative Preferred. Participating Preferred. Convertible Preferred. Redeemable or Callable Preferred. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Corporate Financing Venture Capital: start-up businesses and high-risk enterprises need start-up and expansion capital. The start-up typically gives a share of its stock. Private Equity Capital: obtain capital from wealthy investors. Ultimately, the company may sell shares in an IPO. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.