Corporations
Corporations
A separate legal entity (a “person”)
owned by investors (shareholders)
and managed by a board of directors
□ Corporate Characteristics (Advantages)
➢ Continuity of Life—“Perpetual Life”
Corporation does not automatically terminate on change of shareholder.
➢ Centralization of Management
Board of directors elected by shareholders manages business.
Directors appoint officers (president, vice president, secretary) to manage daily operations.
➢ Limited Liability
Shareholders have limited personal liability.
➢ Free Transferability of Interests
Ownership of corporations may be transferred.
Exception: closely held corporations
□ Disadvantages of Corporate Form
➢ Corporate Formalities
Must be complied with to maintain corporate status (liability protections)
For example, articles of incorporation, bylaws, annual shareholders’ meetings, regular board of directors’ meetings, and so on
➢ Taxation Considerations
Double Taxation
First, corporate person is taxed.
Second, shareholders are taxed when corporate profits (dividends) are paid.
Exception: close corporations
Corporate Forms
Basic Forms
Business Corporations
Statutory Close Corporations
Specific Categories of Businesses
Nonprofit Corporations
Professional Corporations
IRS Designation
S Corporation
Receives pass-through taxation
□ Business Corporations
Basic form for all corporate forms
owners = shareholders (investors without liability)
managers = board of directors or officers
Advantages
1. perpetual life
2. centralization of management
3. limited liability
4. free transferability of ownership
Disadvantages
1. corporate formalities
2. double taxation
□ Statutory Close Corporation
Small corporation (e.g., family owned)
50 or fewer shareholders (Nevada: 30 or fewer)
Shareholders also manage; therefore, stock ownership is restricted. Restriction is on stock certificate.
➢ Formation
Statutory close corporation election in articles of incorporation
➢ Organization
Managed by shareholders
Organized pursuant to shareholders’ agreement
➢ Minimal Corporate Formalities
Board of directors not required
Bylaws not required
Annual shareholders’ meetings not required
main advantage = stock transfer restrictions
□ Professional Corporation
Traditionally sole proprietors or partnerships
Theory: hold professionals accountable for services
➢ Special Considerations
• Name must specify
P.C. (professional corporation)
P.A. (professional association)
S.C. (service corporation)
• Liability Protections
More restrictive than other corporations
Limited personal liability for negligence or malfeasance of associates
• Ownership Restrictions
Only by professionals
Theory: eliminates profit motives of investors
□ Nonprofit Corporation
(charitable, educational, cultural, religious, etc.)
1. limits liability of benefactors
2. offers taxation exemptions
□ S Corporation
IRS designation but not a separate corporate form
Small corporations (less than 75 shareholders) Shareholders—individuals or extensions of individuals (trusts, estates, etc.)
Advantages Disadvantages
Perpetual Centralization Limited Free Transferability Formalities Double
Life of Management Liability of Interests Taxation
Business x x x x x x*
Close x x x x*
Nonprofit x x x x x Exempt
Professional x x** x x*
* Unless S election is made
** All professionals remain personally liable for their own negligence or malfeasance and that which they supervise or have knowledge of.
Formation of a Corporation
Creating the corporation
□ Preincorporation Considerations
➢ Organization
• Corporate Organizers
Promoters
organize corporation
lease business property
buy business equipment
hire employees
solicit investors
Incorporators
sign and file
articles of incorporation
Generally, promoters have a role only in large corporations. Also, promoters and incorporators often are the same people and become shareholders in the corporation.
Selection of Jurisdiction
MBCA and RMBCA—uniform laws
Reduce forum shopping
Corporate Financing
Potential investors agree to purchase corporate shares once corporation is formed.
= preincorporation share subscriptions
Corporate Name
Designate one of the following:
“Corporation”
“Incorporated”
“Company”
Name may not be deceptively similar to another corporate name (to prevent consumer confusion and unfair competition).
Large corporations intending to expand markets reserve their corporate names.
□ Preincorporation Document Preparation
➢ Formation
File articles of incorporation with secretary of state.
Acceptance of articles of incorporation =
beginning of corporate life
Articles of incorporation are an informational filing with the secretary of state. Look to state statute.
name of corporation
purpose of corporation
capital structure of corporation
registered agent
initial board of directors
Note: Provide minimal information because articles of incorporation are available for public inspection and difficult to amend.
□ Postincorporation Procedures
Organizing = bylaws and meetings of incorporators and directors
➢ Bylaws (operating procedures)
= written guidelines and procedures for operation and management
dates and places of shareholders’ and board of directors’ meetings
voting of board of directors
duties of board of directors or officers
stock issuance and ownership
corporate finances (e.g., bank accounts)
➢ Organizational Meeting
By incorporators or initial directors
Purpose
elect directors (if none in articles of incorporation)
appoint corporate officers
approve articles of incorporation
adopt bylaws
ratify preincorporation transactions
□ Defective Incorporation Doctrines
de jure corporation = valid corporation
Corporation complies with all state statutory requirements, so corporation cannot be set aside and shareholders cannot be held liable for corporate debts.
But if a corporation does not comply with statutory requirements, then corporate structure may be set aside and shareholders may be personally liable for obligations of corporation.
A defective corporation, however, may be saved according to one of the following theories:
De Facto Corporation
Business owner has in good faith
1. attempted to comply with state statutory requirements and
2. operated as corporation (e.g., uses corporate name)
Creditor cannot set aside corporate structure.
But state can always challenge corporate status.
Corporation by Estoppel
If party to a contract represents self as corporation,
other party cannot set aside corporate existence.
Applicable only to contract disputes
Reflects contract expectations
□ Taxation Considerations
Federal Income Taxation
Corporation is taxed as “person.”
Shareholders are taxed on dividends.
Exception: S corporations are offered pass-through taxation.
State Income Taxation
Prorated state taxing
Each state in which corporation transacts business may tax corporation.
Corporate residence versus sales profits
Corporate Organizational Structure
Shareholders ……….……………………Corporate Owners
Elect directors
Vote on extraordinary corporate matters
Directors ………..………………………………Policy Makers
Make corporate policy
Determine management of corporation
Officers ……………………..………………Daily Managers
Implement corporate policies
Manage daily operations of corporation
Shareholders
Corporate owners
Contribute investment capital for shares
Ownership = right to receive corporate profits, elect and remove directors, vote on extraordinary corporate matters, receive corpororate assets in dissolution.
No management rights, therefore, no personal liability
□ Shareholders’ rights
➢ Inspection rights
Inspect corporate books to oversee management
➢ Voting Rights
• Elect and Remove Directors
• Extraordinary Corporate Matters
Amendment of articles of incorporation
Mergers
Sale of corporate assets not ordinary
Dissolution
• Voting Mechanisms
quorum = minimum number of shares for valid vote
1. per articles of incorporation or bylaws
or
2. RMBCA = majority of votes
majority of quorum = binding vote
adjourn and reschedule if no quorum
• Proxies
Another person votes shareholder’s vote.
➢ Preemptive Rights
Shareholders’ right to maintain proportionate ownership interest (i.e., control of corporation)
Prevents outsiders from taking over corporation
➢ Meeting Rights
• Meeting Prerequisites
Shareholders eligible to vote
Shareholders owning stock on date of notice of meeting (record date)
Notice of meetings (date, place, time)
Shareholders must have reasonable notice.
May waive notice
• Shareholders’ Meetings
1. Annual meetings
Purpose: elect new directors
Other matters: amend articles,
consider mergers
2. Special meetings
Held between annual meetings
3. Meetings by written consent
Votes must be unanimous (all shareholders).
Minutes of corporate meetings must be maintained.
□
□ Shareholders’ Liability
Shareholders generally have no personal liability
= veil between corporation and shareholders
➢ Piercing the Corporate Veil
But veil may be pierced
1. 1. to prevent fraud or injustice
2. 2. if a shareholder personally guarantees loans
Three reasons
1. lack of corporate formalities
2. commingling of assets
3. inadequate capitalization
➢ Personal Guarantee by Shareholder
Voluntary agreement by shareholder to be personally liable for specific debts of corporation (maintains liability protections for other debts)
Purpose: financing for corporation
Directors
Corporate policy makers
□ Election of Directors
Directors are elected by shareholders at annual meetings.
➢ Voting Mechanisms
Plurality of outstanding shares
Cumulative voting versus straight voting
➢ Removal of Directors
10 percent vote to remove director
□ Directors’ Duties
➢ Management Responsibilities
make corporate policy
declare corporate dividends
elect and remove officers of the corporation
initiate extraordinary corporate matters
➢ Directors’ Meetings (look to bylaws)
Voting requirements and restrictions
Majority of directors must be at meeting for valid vote.
➢ Fiduciary Duties
• Duty of Care
Reasonably prudent director standard
Business judgment rule
• Duty of Loyalty
Conflict of interest
1. Personal interest in corporate transaction
full disclosure
a. disclose interest
b. transaction fair to corporation
2. Usurpation of corporate opportunity
3. Insider trading
Trading on corporation’s stock with inside information (information not available to general public)
• Directors’ Liability
Director and liability insurance
Provides director’s protection from suit
Ultra Vires Acts
Director exceeds authority granted
Breach of Fiduciary Duties
Duty of Care
Duty of Loyalty
Conflict of interest
Usurpation of corporate opportunity
Insider trading
Officers
Corporate (daily) managers
□ Appointment and Removal of Officers
□ Officers’ Duties
President oversees general management
Vice President has variable duties
Secretary keeps records of corporation
Treasurer is responsible for financial affairs
□ Agency
Officers are agents of corporation.
➢ Express Authority
Granted by
articles of incorporation
bylaws
board of directors
➢ Implied Authority
Authority that public assumes of officer
➢ Apparent Authority
Corporation gives impression officer has authority.
Purpose: to protect public from unauthorized acts of officers
□ Fiduciary Duties
➢ Duty of Care
➢ Duty of Loyalty
Breach of fiduciary duties
Creates personal liability
Business judgment rule
Fundamental Changes in
Corporate Structure
□ Fundamental Changes
merger
consolidation
sale, lease, exchange of corporate assets not in the
ordinary course of business
amendment to articles of incorporation
dissolution
□ Standard Approval Procedure
Board of directors and shareholders must approve change.
(File articles of amendment.)
➢ Board of Directors’ Approval
Is change in best interests of shareholders?
If approved, then submit to shareholders.
➢ Shareholders’ Approval
Approved by majority (or two-thirds)
Dissenters’ rights
Fundamental Changes
1. Amendment to Articles of Incorporation
Articles create and organize; therefore,
amendment = fundamental change
File articles of amendment with secretary of state.
2. Merger
One or more corporations (merged corporations) absorbed into
another corporation (surviving corporation)
File articles of merger with secretary of state.
3. Consolidation
One or more corporations merge and form a new corporation
File articles of consolidation with secretary of state.
4. Sale of Corporate Assets
Corporation buys all or substantially all of the assets of another corporation (not in ordinary course of business).
Purpose: escape liabilities of selling corporation
(5. Hostile Takeovers)
Take over management, ownership, or both of corporation without approval of board of directors or shareholders.
6. Dissolution of Corporation
Two-step process: a. dissolve corporate form
b. liquidate corporate assets
□ Dissolution
1. Voluntary
By board of directors or shareholders
2. Involuntary
Because of poor or ineffective management
Dissolved by state, shareholders, or corporate creditors
➢ Liquidation of Corporate Assets
Turning assets into cash
1. creditors’ claims
Paid before distribution to shareholders
2. distributions to shareholders
➢ File Articles of Dissolution
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