CHAPTER 38 Corporations Formation and Financing West s Business Law

CHAPTER 38 Corporations—Formation and Financing West’s Business Law 10 th Edition Kenneth W. Clarkson, University of Miami Roger Le. Roy Miller, Institute for University Studies, Arlington, Texas Gaylord A. Jentz, University of Texas, Austin, Emeritus Frank B. Cross, University of Texas, Austin COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 1

§ 1: The Nature of the Corporation üA 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. üThe shares (stock) of a corporation are owned by at least one shareholder (stockholder). COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 2

Nature of the Corporation üThe corporation substitutes itself for the natural persons in conducting corporate business and incurring liability, but its authority and liability are separate and apart from the shareholders. üIn certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 3

Corporate Personnel üIndividual shareholders own corporation. üShareholders elect board of directors to manage corporation. üBoard of directors hires officers to run corporation on a daily basis. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 4

Corporate Personnel üBody of shareholders can change constantly without affecting the continued existence of the corporation. üShareholder can sue corporation and be sued by corporation and bring suit for corporation in some instances (derivative action). COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 5

Corporate Taxation üCorporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. üCorporate profits are taxed under federal and state law as a separate “person” from its shareholders. üRegular “C” corporations are taxed twice: at the corporate level and at the shareholder level. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 6

Constitutional Rights of Corporations üA 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, liability or property. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 7

Constitutional Rights of Corporations üCorporation’s rights (cont’d): § Freedom from unreasonable search and seizure and double jeopardy. § Freedom of speech. • Only officers and directors have protection against selfincrimination. § However, corporations do not have full protection of privileges and immunities clause. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 8

Torts and Criminal Acts üA 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. üCorporation can be liable for criminal acts, but only fined. Responsible officers may go to prison. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 9

Corporate Sentencing Guidelines üFederal Organizational Corporate Sentencing Guidelines provide specific sentencing guidelines for crimes committed by corporate employees (white collar crime). § 32 levels of offenses: • Culpability score. • Credits can be applied. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 10

§ 2: Corporate Powers üA 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. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 11

Express Powers üThe 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. üCorporate by-laws may also grant or limit a corporation’s express powers. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 12

Implied Corporate Powers üCorporation 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. üA corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 13

Ultra Vires Doctrine üCorporate acts are beyond the express or implied powers of the corporation as stated in state statute or the corporation’s own articles of incorporations and are considered to be “ultra vires” (beyond the powers). üCorporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 14

Ultra Vires Doctrine üThe Following remedies are available for ultra vires acts: § Shareholders can bring action for corporation. § Corporation can recover damages from its officers and directors. § Attorney general of state may bring action to dissolve corporation for ultra vires acts. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 15

§ 3: Classification of Corporations üDomestic corporation does business in its state of incorporation. üForeign corporation from X state doing business in Z state. üAlien Corporation: formed in another country doing business in United States. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 16

Classification of Corporations üPublic and Private. üNonprofit. üClose Corporations. § Shares held by few shareholders. § More informal management, similar to a partnership. § Restriction on transfer of shares. § Case 38. 1: Salt Lake Tribune Publishing Co. v. AT&T Corp. (2003). COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 17

Classification of Corporations ü“S Corporations”: Avoids the federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. IRS requirements: § Corporation is domestic, fewer than 75 shareholders, only one class of stock, no shareholder can be a nonresident alien. üProfessional Corporations. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 18

§ 4: Corporate Formation üThe process of incorporation generally involves two steps: § Preliminary and Promotional Activities; and § The Legal Process of Incorporation. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 19

Incorporation Process Promotion File Articles of Incorporation Name Search State Charter COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. Subscribers 1 st Organizational Meeting 20

Promotional Activities üBefore corporation is formed, promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 21

Promoter’s Liability üA Promoter (or corporation) can create a prospectus required by federal and state securities laws to inform and protect investors. üPromoter is personally liable for preincorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 22

Promoter’s Liabilities ü After corporate formation, corporation can adopt the preincorporation contract and release the promoter by creating a “novation”. ü Subscribers and Subscription Agreements: continuing contracts to purchase stock. Generally, subscribers become stockholders upon corporate formation. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 23

Incorporation Procedures üState Chartering: § Case 38. 2: Bullington v. Palangio (2001). § Select state (some states such as Delaware cater to corporations http: //www. state. de. us/corp/ ). § 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. See sample articles of incorporation at the Texas Secretary of State. http: //www. sos. state. tx. us/corp/forms. shtml COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 24

Incorporation Procedures üChoose and reserve a Corporate Name must have the proper suffix: “Corporation, ” “Corp. , ” “Incorporated. ” üYou should also consider registering the corporation as a “dot com” at networksolutions. com or register. com. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 25

Incorporation Procedures üPurpose: trend towards “any legal business. ” üDuration: usually perpetual. üCapital Structure: Most states require some minimal capitalization (Texas requires $1, 000), plus number and class(es) of shares authorized and “par value” of shares at incorporation. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 26

Incorporation Procedures üInternal Organization: usually included in the bylaws. üRegistered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3 rd parties. üIncorporators (usually the promoter): at least one with name and address. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 27

First Organizational Meeting üAfter the corporation is “chartered” (created) it can do business. üShareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 28

§ 5: Improper Incorporation üErrors in incorporation procedures when a 3 rd party seeks to bring an action against a corporation that may not have complied perfectly with every incorporation law. üProblematic for shareholders who may be personally liable. üIn addition, entity may not be able to enforce contracts. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 29

Improper Incorporation ü De Jure: substantial statutory requirements are met; cannot be attacked by state or 3 rd parties. ü De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law; corporate status can only be attacked by state. ü By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 30

§ 6: Disregarding the Corporate Entity ü“Piercing the Corporate Veil” occurs when a court, in the interest of justice or fairness, ” holds shareholders personally liable for corporate acts. üCourt concludes that shareholders used corporation as a “shield” from illegal activity. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 31

Piercing the Corporate Veil üFactors a court considers: § 3 rd party tricked into dealing with a corporation rather than the individual. § Corporation is set up never to make a profit or remain insolvent or is under capitalized. § Statutory formalities are not followed. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 32

Piercing the Corporate Veil üCorporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. üCase 38. 3: In re Flutie New York Corp. (2004). COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 33

§ 7: Corporate Financing üBonds § § § v. Debt Fixed ROI No votes Optional Priority over stock Stocks Ownership/equity Dividends (variable) Vote for Management Required Paid last üStocks: Common vs. Preferred COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 34

Bonds Type Definition Debentures No specific corporate assets are pledged as collateral. Backed by corporation’s general credit rating. Mortgages Pledge specific real estate. If corporation defaults, bondholders can foreclose. Convertible Conditions trigger bonds to convert to corporate stock. Callable Can be “called in” by principal and repaid according to bond conditions. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 35

Stocks üCommon Stock: represents true ownership of a corporation. Provides pro-rata (proportional) ownership interest reflected in control, earnings and assets. üPreferred Stock: has preferences over common stock. § Cumulative Preferred. § Participating Preferred. § Convertible Preferred. § Redeemable or Callable Preferred. COPYRIGHT © 2006 West Legal Studies in Business, a part of The Thomson Corporation. Thomson, the Star logo, and West Legal Studies in Business are trademarks used herein under license. 36