ACC 612 Corporations

What is the difference between S and C Corporations?

How they are taxed. C corps get double taxation

What is a Corporation (key points)

• It is a legal entity, treated as an artificial person under the law.

  • Separate tax-paying entity

  • double taxation

• It is owned by shareholders

• They are formed under state incorporation statutes.

What separates corporations from other entities?

• Perpetual existence

• Centralized management

  • Board of directors makes policy decisions

  • Board appoints officers to conduct day-to-day operations.

Characteristics of Corporations

• Limited liability of shareholders

  • Shareholders are liable only to the extent of their contribution

  • Shareholders have no personal liability for debts of a corporation

• Free transferability of shares.

  • Shareholders may agree to restrictions. (buy-sell agreements)

What are buy-sell agreements?

Buy-sell agreements limit ownership rights, requiring shares to be resold to the organization or current partners when an owner leaves or passes away

Classification of Corporations

• Profit corporations 

  • Publicly held corporations (C corps)

    • Usually have many shareholders

  • Closely held corporations

    • Usually have few shareholders

    • Shareholders are frequently involved in management of the corporation

    • Doesnt sell stock to public

• Not-for-profit corporations

  • Formed for charitable, educational, religious, or scientific purposes.

  • May not distribute profits to members.

S Corporation key facts

• S Corps do not pay corporate income tax, but income or loss flows to shareholders

  • Files an informational return - 1120s

• Some criteria for S corps:

  • Must be incorporated in the US

  • Must be eligible

    • Certain financial institutions and insurance companies cannot be S corporations

  • Shareholders must be individuals, estates or certain trusts (no corporations or partnerships)

  • Can have no more than 100 shareholders. Spouses count as 1.

  • Family members in a six generation range are considered 1 shareholder.

  • There can only be one class of stock

  • Nonresident alien shareholders are generally prohibited

  • need consent of all shareholders

S Corporations Termination

• Revocation by the majority of shareholders

• An eligibility requirement not being satisfied on any one day.

• If a C corp converted to S status but didn’t fulfill the requirements. (they didnt distribute earnings and over 25% of gross receipts was due to passive investment income - rental, dividend, interest income).

Formation of a Corporation

• Promoters procure capital commitments

  • Pre-incorporation stock subscriptions

    • Generally irrevocable for 6 months

    • some states require it to be written

  • Other contracts

• Promoters are generally personally liable on contracts unless there is a novation (substitution of old contract by new contract)

  • Promoters are NOT agents

• Corporations may adopt contracts of promoters (which causes them to be liable)

  • May be implied by accepting benefits

Incorporation Procedures - State selection

• Select a state for incorporation

  • Domestic corporation - a corporation doing business in the state which it was formed

  • Foreign corporation - a corporation doing business in any other state other than the one in which it was formed

  • Alien corporation - a corporation incorporated in another country

Incorporation Procedures - Articles of incorporation

• Articles of incorporation are filed with the state and must be signed by at least one incorporator

• Articles include the following information:

  • Name of corporation

  • Number of shares authorized

  • Address of registered office and agent

  • Name and address of each incorporator

• Some states require a purpose clause

  • Ultra vires

Incorporation Procedures - Bylaws and Org Meeting

• Corporate bylaws

  • Govern internal management of the corporation

  • Are binding on directors, officers, shareholders.

  • Not required to be filed

  • May not conflict with articles of incorporation

  • Can be amended by the board OR by the shareholders unless reserved to the shareholders in the articles

• Organizational meeting

  • Directors adopt bylaws, authorize stock, adopt promoters’ contracts, elect officers

Financing the Corporation - Stock

• Common Stock

  • Residual value

• Preferred stock

  • Dividend Preference

  • Liquidation preference

  • cumulative dividend right

    • dividends in arrears

  • paricipating

  • convertible

  • callable - buy back rights at predetermined price

Financing the Corporation - Authorized shares

• Issued (sold at one point)

• Unissued (not sold yet)

• Outstanding (in the hands of shareholders)

• Treasury

  • No preemptive rights. does not have the right to purchase shares before they are offered to other shareholders

  • Not voting rights

  • No right to dividends

Financing the Corporation

Debt securities

• Debentures - long-term unsecured debt

• Secured Bond - also called a mortgage bond

• Note - short term debt, may be secured or unsecured.

Shareholders - key points

• Shareholders own the corporation, are not agents of the corporation

• Shareholders’ meetings

  • Annually - required

  • Special meetings may be called by board of directors, the president, or persons holding at least 10% of the outstanding voting share.

Shareholders’ Voting Rights

• Shareholders have the right to elect or remove directors

• Shareholders have the right to vote on fundamental changes:

  • Dissolution

  • Amending the articles of incorporation

  • Mergers (other than short form)

  • Consolidations

  • Sale of substantially all of the corporate assets.

Shareholder voting

• Quorum and vote required

  • A majority of voting shares is required for a quorum.

  • A vote by the majority of voting shares represented at the meeting is considered an act of shareholders (plurality needed to elect directors)

• Proxies

  • Shareholder can appoint another person as their agent t vote

  • the written document authorizing this is called a proxy

• Voting trusts (trustee votes) and Voting Agreements must be written.

Types of Voting

• Supermajority - corporation bylaws may require a greater number than a majority (example, 2/3 majority)

• Straight (noncumulative) voting - each shareholder votes the number of shares they own for each candidate.

• Cumulative voting - each shareholder may accumulate votes or split them. Each voter is allowed as many votes as there are candidates and may give all to one candidate or varying numbers to several.

Shareholder's’ Rights

• Preemptive rights - an existing shareholder may have the option of purchasing new shares in proportion to the amount they already own

  • Must be reserved in the articles

• Right to inspect the books and records

  • Proper purpose

    • Derivative suit-shareholder brings action on behalf of the corporation when the directors have failed to do so.

    • Investigating the possible misconduct

    • Proxy solicitation

  • Improper purpose

    • Get names for retail mailing list.

Dividends - cash/property/stock

• Share of profits paid to shareholders - cash or property

• Paid at the discretion of the board of directors

• Solvency generally required

• If board of directors declare dividend, then it cannot be revoked.

  • Shareholders become unsecured creditors if dividend is declared.

• Stock (not cash) dividends do not affect total equity.

  • Just shifts $ from retained earning to contributed capital

Derivative Lawsuits

• The board of directors has the authority to sue on behalf of the corporation

• If the board fails to bring suit, shareholders have the right to bring a derivative lawsuit on behalf of the corporation

• In order to bring a derivative lawsuit, the shareholder:

  • Must have been a shareholder at the time of the act complained of, and

  • fairly and adequately represent the corporation’s interest, and

  • have made a written demand on the corporation to take suitable action

Piercing the Corporate Veil

• Shareholders generally have limited liability

• If a shareholder dominates a corporation and uses it for improper purposes, a court of equity can disregard the corporate entity (pierce the corporate veil) and hold the shareholder personally liable for the corporation’s debts and obligations

  • Commingling funds

  • Corporate formalities are ignored

  • Undercapitalization - thin capitalization

Board of Directors

• The board of directors of a corporation is responsible for formulating the policy decisions affecting the management, supervision, and control of the operation of the corporation

• inside director - a person who is also an officer of the corporation

• outside director- a person who is not an officer of the corporation.

Meetings of the board of directors

• Regular meetings are held at times established by the corporate bylaws

• Committees of the board of directors usually include:

  • Executive committee

  • Audit committee

  • Nominating committee

• Some board powers cannot be delegated to committees:

  • Example: declaring dividends, amending bylaws, authorizing shares.

Corporate Officers

• Board of directors has authority to appoint officers of the corporation

• Most corporations have 

  • President

  • Vice presidents

  • Secretary

  • Treasurer

• Bylaws may authorize appointed officers to appoint assistant officers

• Officers (not directors) are agents.

Liability of Directors and Officers

• Directors and officers owe fiduciary duties to the corporation and its shareholders, including

  • Duty of loyalty

  • Duty of care

Duty of Loyalty

• Breaches of the duty of loyalty include:

  • Usurping a corporate opportunity

  • self-dealing/making a secret profit

  • Competing with the corporation

• Not a conflict of interest if transaction is:

  • Fair to corporation

  • Full disclosure

  • approved by a majority of informed and disinterested board members.

Duty of Care

• Officers and directors have the duty to use care and diligence when acting on behalf of the corporation. This duty of care includes the duty to:

  • Act in good faith

  • Act with care of an ordinary prudent person in similar circumstances

• Business Judgement Rule - duty of care is measured as of the time of the decision - rule recognizes that the directors and officers - not courts and shareholders - are best able to make business judgements.

Corporate Criminal Liability

• Directors, officers, employees, and agents have personal liability for crimes committed while acting on behalf of the corporation

• The corporation is liable for crimes committed by directors, officers, employees, or agents acting within their scope of employment

  • Respondeat superior - let the master answer

Consolidation

Two or more corporations combine so that each corporation ceases to exist and a new one emerges

A + B = C

Mergers and Acquisitions

• A merger occurs when one corporation is absorbed into another corporation and ceases to exist

• Requirements for merger

  • Recommendation of board of directors of each corporation

  • approval of majority of shareholders of each corporation

  • merger plan

• Dissenting shareholder appraisal right

  • Written notice before vote

  • fair value

Example of a merger

Corp A + Corp B = Corp A

Mergers

• Short-form merger

  • Occurs when parent corporation owns at least 90% of the outstanding shares of each class of stock of the subsidiary corporation

  • shareholder approval is not required

  • board of directors of parent corporation must approve plan

Tender Offer

• If the board of directors of the target corporation does not agree to a merger, the acquiring corporation may make a tender offer directly to the shareholders.

Fighting a Tender Offer

• Management of a target company may fight a tender offer in various ways

  • Persuasion of its shareholders

  • Selling a “crown jewel” (key asset(s)

  • Adopting a poison pill - make takeover incredibly expensive - offer shares to existing shareholders at reduced or no cost

  • White knight merger - the friendly acquirer strategy.

  • Reverse tender offer - the target firm then tries to acquire the company that has made a hostile takeover attempt.

  • Issuing additional stock

  • Creating an employee stock ownership plan (BASED!)

  • Greenmail - target buys back acquired shares at a premium.

Dissolution

• Voluntary dissolution by:

  • Unanimous written consent of all shareholders, OR

  • A majority shareholder vote at a special meeting called for the purpose of the directors have adopted a resolution of dissolution. a majority of the shares entitled to vote must be represented at the special meeting.

• Judicial dissolution