1. THE CORPORATE FORM May 30, 2007

2. The Nature of Corporations
The basic underpinnings of corporations are the same as those of unincorporated forms of businesses:
Agency law: authority and apparent authority
Fiduciary principles: obligations of constituencies to one another
Contract law: nexus of various contractual relationships

3. CORPORATIONS ARE CREATURES OF STATUTE AND ONE MODEL SAYS THEY ARE A NEXUS OF CONTRACTS

4. They have a “contract” with:
The state of incorporation, which sets the basic parameters of corporate existence
Various other constituencies who have “contract” rights or legally enforceable expectations vis-à-vis the corporation (i.e., shareholders, directors, officers, employees, suppliers, agents)

5. Who are the Corporate Constituencies?

6. ABC, Inc. Shareholders Advisors Board of Directors Customers Creditors
Management
(CEO, COO, CFO,
Secretary, VPs, etc.)
Employees
Suppliers
Other Constituencies,
The “Community”
Subsidiary

7. When a “corporate lawyer” is engaged, which constituent is his/her client?
The Chief Executive Officer?
The General Counsel?
The Chief Financial Officer?
The Corporation?
The Shareholders?
The Board of Directors?

8. When a corporation engages a lawyer, the corporation is the client
This frequently leads to conflicts of both an ethical nature and a personal nature.

9. A Corporation is a Separate Entity
A corporation is a statutory entity with its own separate legal status. It is legally distinct from its shareholders, directors, officers, and other constituencies. This is called the corporation’s “entity status.”
Note: Remember our study of this concept (versus “aggregate” status) on partnerships?

10. Corporate Characteristics
Limited Liability
Corporation shareholders are not personally liable for corporate obligations
Corporation managers, i.e., officers and directors, are not personally liable for corporate obligations

11. Corporate Characteristics
Free Transferability of Ownership Interests
Corporation stock ownership is freely transferable
Transferability may be limited in certain circumstances
Partnership interests are not, generally, freely transferable

12. Corporate Characteristics
Centralized Management
Corporations are managed under direction and authority of boards of directors
Officers manage day-by-day and report to the board
Shareholders, not management, are ultimate authority

13. Corporate Characteristics
Entity Status
A corporation is a “legal entity” that has rights and powers in its own legal capacity
Owners, i.e., shareholders do not act in the corporate capacity of the corporation

14. Corporate Characteristics
Perpetual Existence
Corporations usually have perpetual existence (except for “special purpose vehicles”—SPVs—or “special purpose entities”—SPEs—formed solely for unique transactions of a limited duration

15. Corporate Characteristics
Double Income Taxation
Corporations pay income tax on income of the corporate entity and shareholders pay income tax on dividends they receive from the corporation

16. DISTINCTIONS BETWEEN CHARACTERISTICS OF CORPORATIONS AND PARTNERSHIPS (See Comparison Chart on TWEN)

17. Distinctions from Partnerships Limited Liability
Corporations:
Shareholders not personally liable for corporation liabilities
Directors and officers not personally liable for corporation liabilities
Partnerships:
Partners personally liable for partnership liabilities
Manager-partners personally liable for partnership liabilities

18. Distinctions from Partnerships Transferability of Interests
Corporations:
Ownership of shares is freely transferable, except in certain circumstances (e.g., “restricted securities,” shareholder agreements)
Partnerships:
Partnership interests are generally not freely transferable without partners’ consent

19. Distinctions from Partnerships Centralization of Management
Corporations:
The board of directors oversees the affairs of the corporation
Officers are day-to-day managers and report to the board
Shareholders are the ultimate governing authority
Partnerships:
Absent agreement to the contrary, partnerships are managed by the partners collectively and the majority vote dictates

20. Distinctions from Partnerships Entity Status
Corporations:
A corporation is a legal entity that acts in its own legal capacity, e.g., it may hold property, dispose of property, and sue and be sued in its own name
Partnerships:
Although modern partnerships are entities, an act of a general partner of a partnership is an act of the partnership and vice versa because of personal liability of partners

21. Distinctions from Partnerships Duration of Existence
Corporations:
A corporation usually has perpetual existence
Partnerships:
Partnerships effectively dissolve on exit of a partner unless 2 or more continue without liquidation or settlement of the business

22. Distinctions from Partnerships Income Taxation
Corporations:
Double taxation of corporate income and shareholder dividend income
Partnerships:
“Pass-through” taxation to partners of partnership income

23. Factors in Selecting Business Form
Considerations of
Internal efficiency
Operational cost
Organizational convenience
Limited liability and responsibility of owners for debt and other types of liabilities
Minimization of income tax liability

24. Organizing a Corporation
Choice of state of incorporation
“Close corporations” almost always incorporate in the state of their principal place of business because of:
Convenience
“Doing business” and “franchise” taxes may overlap and tax savings may result
Local advisers (lawyers, accountants, etc.) are familiar with local and state laws
Intrastate securities offering exemption
No “foreign” corporation registration

25. Organizing a Corporation
Choice of state of incorporation
Publicly held corporations have other considerations and may or may not incorporate in the state of their PPB. Convenience, immaterial tax savings, and local experts are not as important to them.

26. Organizing a Corporation
Choice of state of incorporation
Delaware has become, since the 1940s, a preferred incorporation forum because of advantageous management and corporate statutory law. There is also an abundant body of corporate case law. More than half a million business entities are incorporated in Delaware including more than 50% of all U.S. publicly-traded companies and 58% of the Fortune 500. 

27. Organizing a Corporation Process
Name reservation. § 10-2B-4.01 to -4.03
Choose 1 or more incorporator. § 10-2B-2.01
Select, clear, and reserve corporate name. § 10-2B-4.01, -4.02
File articles of incorporation. § 10-2B-2.03

28. Organizing a Corporation Process
Question: What is the legal act of incorporation?
The filing of articles of incorporation. See § 10-2B-2.03(a).

29. Organizing a Corporation Process
In organizing a corporation, the fundamental documents include, at a minimum:
Articles of Incorporation
Bylaws
Minutes of an organizational meeting of (1) the incorporators, (2) the subscribers for stock or stockholders, or (3) subsequent to incorporation, the initial directors named in the articles of incorporation

30. Organizing a Corporation Process
Articles of incorporation—10-2B-2.02
The mandatory contents of articles of incorporation are dictated by statute, but additional optional provisions may be added. Need capital structure; agent for service-of-process in Alabama; office street address; initial director(s); corporate purpose(s).

31. Alabama Secretary of State Form Articles
STATE OF ALABAMA
DOMESTIC FOR-PROFIT CORPORATION
ARTICLES OF INCORPORATION GUIDELINES
PURSUANT TO THE PROVISIONS OF THE ALABAMA BUSINESS CORPORATION ACT, THE UNDERSIGNED HEREBY ADOPTS THE
FOLLOWING ARTICLES OF INCORPORATION.

32. Alabama Secretary of State Form Articles
Article I The name of the corporation:
Article II The duration of the corporation is “perpetual” unless otherwise stated.
Article III The corporation has been organized for the following purpose(s):
Article IV The number of shares which the corporation shall have the authority to issue is___________.

33. Alabama Secretary of State Form Articles
Article V The street address (NO PO BOX) of the registered office: _______________________
__________________________________________________ and the name of the
registered agent at that office: _____________________________________________.
Article VI The name(s) and address(es) of the Director(s):
Article VII The name(s) and address(es) of the Incorporator(s):

34. Alabama Secretary of State Form Articles
Any provision that is not inconsistent with the law for the regulation of the internal affairs of the corporation or for the restriction of the transfer of shares may be added.
IN WITNESS THEREOF, the undersigned incorporator executed these Articles of Incorporation on this the ____ day of ___________, 20__ (Signature)

35. Organizing a Corporation Process
Bylaws—Section 10-2B-2.06
(a) The board of directors of a corporation shall adopt initial bylaws for the corporation unless the right to adopt the initial bylaws is reserved to the shareholders in the articles of incorporation.
(b) The bylaws of a corporation may contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with law or the articles of incorporation.

36. Organizing a Corporation Process
The Bylaws are, essentially, the rules of operating the corporation. However, any provision of the Bylaws that is inconsistent with the Alabama Business Corporations Act or the articles of incorporation is trumped by the ABCA or articles.

37. Organizing a Corporation Process
An organizational meeting of the initial directors typically includes the following business items:
Election of a chairman of the board
Election of officers
Adoption of Bylaws
Fixing number of directors (unless fixed in the articles of incorporation)

38. Organizing a Corporation Process
An organizational meeting of the initial directors typically includes the following business items (continued):
Authorization of issuance of capital stock
Approval of bond
Approval of corporate seal
Authorization of corporate bank accounts
Other business

39. Organizing a Corporation Process
Consequences of defective incorporation may be harsh.
In Cantor v. Sunshine Greenery, Inc. (NJ Sup. Ct. 1979), what was the effect to the corporate organizers that the corporation was held to be a de facto corporation?

40. Organizing a Corporation Process
In the event of the absence of a de facto or de jure corporation, a defectively formed corporation is not a corporation. The default form of business organization would be a sole proprietorship or general partnership, resulting in personal liability for the owners.

41. De Jure Corporation We’re talking…
de jure (Latin: “by law” or “by right”),
not
du jour (French: du, “of the” + jour, “day”)

42. Organizing a Corporation Process
A de jure corporation is one that exists as a matter of law by reason of full compliance by incorporators with the requirements of law.
A de facto corporation is one that is deemed to exist under color of law, despite omission of an essential element of organization, based on a good faith effort to comply.

43. Organizing a Corporation Process
A fundamental condition precedent to protection of the owners afforded by the de facto incorporation doctrine is a good faith attempt to comply with the incorporation statute.

44. Organizing a Corporation Process
In Cantor, did the organizers evidence a good faith attempt to comply?
The act of executing the articles, the bona fide effort to file them, and dealings with plaintiffs in the name of the corporation demonstrated the requisite good faith.

45. Organizing a Corporation Process
Incorporation by estoppel. Based on the theory that those who hold forth an enterprise on the basis that it is a corporation or those who deal with an enterprise as if it were a corporation, knowing otherwise, should, as a matter of equity, be prevented—”estopped”—from treating it as anything else.

46. Organizing a Corporation Process
Black’s Law Dictionary (8th ed. 2004) defines “corporation by estoppel” as “a business that is deemed, by operation of law, to be a corporation because a third party dealt with the business as if it were a corporation, thus preventing the third party from holding a shareholder or officer of the corporation individually liable.” The definition can cut both ways.

47. Liability for Preincorporation Transactions
The general rule is that when a promoter makes a contract for the benefit of a corporation that has not yet been organized, the promoter is personally liable on the contract and remains liable after the corporation is organized. Further, the corporation is not liable for the contract after the corporation is organized due to a lack of authority unless the corporation ratifies or adopts the contract or there is a novation of the contract.

48. Liability for Preincorporation Transactions
The exception to the general rule that a promoter is liable for preincorporation contracts is that if the party who contracts with the promoter knew that the corporation was not in existence at the time of the contract, and nevertheless agreed to look solely to the corporation for performance, the promoter is not deemed to be a party to the contract and is not liable for it.

49. Ala. Code § 10-2B-2.04
“Any person purporting to act as or on behalf of a corporation, knowing there was no incorporation under this chapter, is liable for all liabilities created by so acting.”
This is a MBCA provision and is consistent with the general rule. However, before the adoption of this statute in 1994, the effect of preincorporation transactions Alabama was left to case-by-case development in the courts.

50. Organizing a Corporation Process
§ 10-2B-2.04 does not preclude imposition of liability under the doctrine of de facto corporateness or equitable principles of estoppel. These remedies are equitable in nature and may correct, supplement, or supercede the common and statute law as applied to particular circumstances.

51. Organizing a Corporation Process
The cases which typically do not fall within these circumstances are those where promoters have incurred obligations in the process of incorporation or where partners who seek to convert a partnership to a corporation incur liability obligations during that process. The key in imposing liability under 10-2B-2.04 is that they knew "there was no incorporation."

52. Organizing a Corporation Process
Knowledge of the non-existence of a corporation de jure is a condition to the application of both § 10-2B-2.04 and the equitable doctrine of incorporation by estoppel.

53. Organizing a Corporation
Capital Structure
Common Stock: Equity interest representing ownership in a corporation. Generally carries the right to vote for directors and certain other matters. Dividends on net profits. The last to get paid after creditors (“residual interest”).

54. Organizing a Corporation Process
Capital Structure
Debt: Trade debt
Bank Debt
Bonds and Debentures

55. Organizing a Corporation
Capital Structure
Debt: Trade debt is money owed for goods and services provided to the corporation. Balance sheet line item is “Accounts Payable.”

56. Organizing a Corporation
Capital Structure
Debt: Bank debt is principal and interest owed to banks and other financial institution lenders. Balance sheet line item is “Loans Payable.”

57. Organizing a Corporation
Capital Structure
Debt: Bonds and debentures are principal and interest owed to lenders other than banks and other financial institution lenders. Balance sheet line item is “Loans Payable” or a more specific description.

58. Organizing a Corporation
Capital Structure
Preferred Stock: A hybrid of an equity security and the senior status of debt instruments. Dividend (cumulative), liquidation, and other preferential elements are inherent to these securities.

59. Organizing a Corporation
Capital Structure
“Derivative Securities”—More exotic securities that are derived from common types of securities. CMOs, trust preferred securities, inverse floaters tied to interest rates are examples.

60. Ultra Vires Doctrine SCOPE OF CORPORATE POWERS
Activities outside the scope of corporate powers

61. Ultra Vires Doctrine
Under traditional theory, a corporation is regarded as a fictitious person endowed with only those powers as are stated in its charter. Activities outside those stated powers are ultra vires, or beyond the corporation’s powers, and unenforceable against the corporation due to a lack of contractual mutuality.

62. Ultra Vires Doctrine
A corporation could raise ultra vires as defense in limited circumstances, but not in cases of:
Corporate torts
Criminal liability
Reversal of completed transactions

63. Ultra Vires Doctrine
Over time, courts implied corporate powers to undermine the doctrine and bind them in transactions that were incidental or auxiliary to their explicit powers.

64. Ultra Vires Doctrine
Modern statutes have effectively abolished the doctrine with general purpose authorization of powers.

65. Ultra Vires Doctrine Purposes.
“Corporations may be organized under this chapter for any lawful purpose or purposes.”
Ala. Code section 10-2B-3.01

66. Ultra Vires Doctrine
In drafting of articles of incorporation, it is now commonplace to state the purpose of the corporation substantially as follows:
“The corporation shall have power to engage in any lawful business.”

67. Money Isn’t Everything
The famous case of Dodge v. Ford Motor Co. (1919)

68. What are the purposes of a corporation?
Maximize shareholder wealth?
Improve humankind and society through charitable giving and service?
Enhance the lifestyle of its employees, especially the CEO and other executives?
Provide expert advice to government?
Improve the effectiveness of government through legislative affairs (i.e., lobbying), political action committees?

69. What are the purposes of a corporation?
Is it all of these things and more?
Do the shareholders have any say in the utilization and expenditure of the corporation’s financial and other resources?
Besides, it’s their money, isn’t it?
What is a proper balance and allocation of corporate resources?

70. Dodge v. Ford Motor Co. (1919) Facts of the Case
What does this case have to do with the ultra vires doctrine or the purposes of a corporation?

71. Dodge v. Ford Motor Co. Henry Ford Ford Motor Co.
58% and board control
Ford
Bro.
Ford
Bro.
10%
32%
Others

72. Dodge v. Ford Motor Co.
Ford had a surplus—excess capital above assets (-) liabilities—of $112MM, including $52.5MM in cash and $1.3MM in muni bonds.
Ford had been paying a regular annual dividend of $1.2MM.
Henry Ford

73. Dodge v. Ford Motor Co.
“My ambition is to employ still more men; to spread the benefits of this industrial system to the greatest possible number; to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business.”
Henry Ford

74. Open PDF The New York Times 1/14/1914 article on Ford

75. Dodge v. Ford Motor Co.
Let’s revisit the corporate structure and the constituencies served by the corporation.
Who would you say is the most important of these constituencies?
Henry Ford

76. ABC, Inc. Shareholders Advisors Board of Directors Customers Creditors
Management
(CEO, COO, CFO,
Secretary, VPs, etc.)
Employees
Suppliers
Other Constituencies,
The “Community”
Subsidiary

77. Dodge v. Ford Motor Co.
Why were Henry Ford’s social concerns not persuasive to the court?
Why should a court interfere with the directors’ discretion not to declare dividends?
Henry Ford

78. Dodge v. Ford Motor Co.
Intel, a corporate giant, and many other large corporations do not pay regular corporate dividends.
Neither did Microsoft until 2003.
Henry Ford

79. Dodge v. Ford Motor Co.
This case is one of the few reported cases where a court interfered with a court’s decision not to declare dividends.
Henry Ford

80. Dodge v. Ford Motor Co.
§ 10-2B-6.40 sets forth the narrow limitations on a board’s discretion to declare and pay dividends “if, as, and when” it deems proper.
Henry Ford

81. Dodge v. Ford Motor Co.
Finally, note that approximately 30 states have enacted “stakeholder” or “other constituency” statutes that authorize boards to consider interests other than shareholder wealth maximization in making corporate decisions.
Henry Ford

82. Dodge v. Ford Motor Co. § 10-2B-304(a) provides:
Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.
Henry Ford

83. Dodge v. Ford Motor Co.
The precise issue presented in Dodge is unlikely to arise again because of the adoption by Congress of an accumulated earnings tax on corporations.
(Note: this tax does not apply to LLCs, presenting a possible choice-of-entity consideration.)
Henry Ford

84. Dodge v. Ford Motor Co.
From 2003 through 2008, the IRS imposes an additional "accumulated earnings" tax of 15 percent on earnings a corporation accumulates above $250,000.
Henry Ford

85. MR. MCCLAIN, OUR ACCOUNTANT, IS THIS STILL RIGHT?
Dodge v. Ford Motor Co.
Although this tax is easy to avoid—for reasons we won’t discuss here—this tax is designed to dissuade corporations from accumulating earnings just to avoid paying taxable dividends.
MR. MCCLAIN, OUR ACCOUNTANT, IS THIS STILL RIGHT?
Henry Ford

86. Dodge v. Ford Motor Co.
Late in the course, we will see these stakeholder statutes come into play when we look at Delaware cases dealing with anti-takeover measures by corporations and their ability to take non-shareholder constituencies into account.
Henry Ford

87. END OF SESSION SLIDES