Chapter 15

Corporation

A fictitious legal entity that exists as an independent "person" separate from its principals. Like a real person it can sue and be sued, make and breach contracts, and even has First Amendment protection for political speech. Its debts and obligations are its OWN, separate from the personal obligations of its owners.

Business corporation law

The specific state statute (every state has one) governing a corporation's internal matters: its structure, oversight of managers, rights of owners in a sale of assets/ownership, and reporting. Corporations are creatures of STATE law, so where you incorporate sets the internal rulebook.

Revised Model Business Corporation Act (RMBCA)

A model corporate statute drafted by the American Law Institute. It standardizes corporate formation and governance rules across states.

Privately held corporation

Owned by a group of private individuals; does not sell ownership interests to the general public. Has no cap on revenues since they arent regulated

Publicly held corporation

A corporation that sells ownership interests to the general public through a stock exchange (e.g., NYSE), usually after an IPO. Heavy federal/state regulation (securities laws, Sarbanes-Oxley), because investors worldwide depend on disclosure.

Unanimous consent resolution

A single document signed by all principals to handle tasks (like electing directors or issuing stock) WITHOUT holding an actual meeting. It's the flexibility tool that lets privately held corporations skip rigid formalities.

Domestic corporation

A corporation in the state where it is incorporated.

Foreign corporation

A corporation in a state OTHER than its state of incorporation when doing business there.

Alien corporation

A corporation formed OUTSIDE the United States that transacts business in the U.S.

Nonprofit corporation

A corporation with no profit-seeking owners that exists to serve the public (charities, schools, some hospitals).

Benefit corporation

A corporation with a DUAL purpose: benefit society AND earn profits for its owners. Unlike a nonprofit, it IS owned by its principals.

Public corporation

A corporation formed by a GOVERNMENT body to serve the public (e.g., public mass transit), with no owners.

Professional corporation

A corporation whose ownership is restricted to members of a licensed profession in good standing (e.g., a law firm owned only by licensed, active attorneys).

Articles of incorporation “corporation birth certificate”

The formation document filed with the state (usually the secretary of state's corporation bureau) setting out the corporation's name, purpose, number of shares issued, and headquarters address.

Promoter

A person who carries out business activities (raising capital, leasing property, hiring) on behalf of a corporation BEFORE it is legally formed. Key rule: the promoter is personally liable for contracts signed when they know the corporation doesn't yet exist. That liability CEASES once the corporation forms AND adopts the contract.

Delaware note

Delaware gives NO tax advantage to out-of-state businesses, so small corporations usually pay MORE by incorporating there.

Debt financing

Raising capital by borrowing, loans backed by a promissory note, or for larger needs, bonds/debentures.

Bond

A form of corporate debt issued to the public: the corporation promises to pay bondholders interest at a set rate for a set time and to repay the full principal at the maturity date.

Maturity date

The date on which a bond's full principal (the entire loan) is repaid to the bondholder.

Equity financing

Raising capital by selling ownership interests. (issuing a security)

Venture capital firm

A group of professional investors who fund a developing business, usually concentrated in one industry. They bring money AND expertise but demand substantial control (board/officer influence) and an exit strategy (often an IPO or premium buyout) — they are not long-term investors.

Initial public offering (IPO)

The complex process of converting a privately held corporation into a publicly held one by selling shares to the general public and financial institutions.

Bylaws

A corporation's internal operating rules (meeting dates, number of officers/directors, election procedures, officer duties).

Shares

Units of ownership interest in a corporation, evidenced by a stock certificate showing the owner's name and number of shares; ownership is tracked in a stock register kept by the secretary.

Shareholders

The OWNERS of a corporation. They don't run it day-to-day; their power is indirect — electing/removing directors and approving or vetoing major decisions. Key limit: shareholders cannot bind the corporation or force directors to take a specific action.

Corporate veil

The legal separation that shields the personal assets of shareholders, officers, and directors from the corporation's debts and liabilities.

Personal guarantee

A promise by a principal to back a corporate loan with their OWN personal assets, letting the creditor get a judgment against those assets if the corporation defaults.

Piercing the corporate veil

When a court sets aside limited liability and reaches the personal assets of shareholders because the corporate form has been abused. There's no single rule; courts weigh the whole picture using FOUR guidepost factors:

inadequate capitalization,

nature of the claim,

fraud/wrongdoing, and

failure to follow formalities.

Piercing factor — Inadequate capitalization

A corporation that is created with very little money or whose owners take out most of its profits and assets may be seen as abusing the corporate structure. This can lead a court to "pierce the corporate veil" because it is only fair that the business have enough resources to meet its obligations.

Piercing factor — Nature of the claim

Courts are LESS likely to pierce for a VOLUNTARY creditor (e.g., a trade creditor who could have demanded a guarantee) and MORE likely to pierce for an INVOLUNTARY creditor (e.g., a pedestrian hit by a corporate truck) who never had a chance to protect against the risk.

Piercing factor — Evidence of fraud or wrongdoing

Fraud or serious, willful wrongdoing — such as misrepresenting the company's finances to creditors or lying to investors about liabilities.

Piercing factor — Failure to follow corporate formalities

Ignoring required practices (no stock issued, no meetings held, no corporate records, no separation between owner and company).

C corporation- taxation

A corporation taxed as a SEPARATE entity: it pays tax on its earnings, and shareholders pay tax AGAIN on dividends.

S corporation

A corporation that qualifies for and elects Subchapter S treatment, giving it flow-through (pass-through) taxation: NO tax at the entity level; income is taxed only once, at the shareholder's individual rate when distributed.

Double taxation

The C corporation tax pattern: income is taxed once at the corporate level when earned, then again at the individual level when distributed to shareholders as dividends.

Corporate structure

Power is allocated among three groups:

SHAREHOLDERS

DIRECTORS

OFFICERS

Directors (the board)

Set the strategy and policies; oversight function; appoint/remove officers

Officers

Carry out the directors' set course; run daily operations (day-to-day) managers

Voting stock

Along with dividends and ownership benefits, they have the right to vote and influence decisions.

Nonvoting stock

Shareholders still receive dividends and ownership benefits they just can't vote on directors and major corporate affairs.

Dividends

Distributions of a corporation's profits to its shareholders.

Election of directors

Shareholders elect directors, who typically serve one-year terms (bylaws can vary this), and a quorum is needed to vote. Some states require at least three directors except for closely held corporations; Delaware has abolished any minimum.

Quorum requirement

The number of shareholders (or directors) who must be present to elect directors.

Removal of directors

Directors can be removed by a shareholder vote (WITH or WITHOUT cause) or by a COURT — but a court removes only FOR cause (such as fraud).

Board meetings & action without a meeting

The board acts only at official meetings, and a MAJORITY of directors present is needed to act. Most states also allow board action WITHOUT a meeting via unanimous written consent or simultaneous communication (e.g., videoconference).

Board committees

Small groups of directors assigned to oversee specific tasks and make recommendations to the full board. Common examples: compensation committee, audit committee, and election committee.

President

Has the implied power to bind the corporation in ordinary business transactions and to oversee nonofficer employees (e.g., signing distribution contracts, hiring/firing employees).

Vice President

Has only LIMITED implied authority, usually tied to their function (e.g., a VP of marketing can bind the corporation to an advertising vendor).

Treasurer

Handles collecting accounts receivable and paying accounts payable, but has little or NO other implied authority.

Secretary

CERTIFY the corporation's records and resolutions; by affixing a signature, the secretary confirms a document is genuine, and third parties may rely on that certification.

Fiduciary duties of insiders

DUTY OF CARE (act with skill, diligence, and care) and the

DUTY OF LOYALTY (no self-dealing or conflicts of interest). Breaching them can mean personal liability.

Duty of care

Officers and directors must exercise the skill, diligence, and care a reasonably prudent person would under the same circumstances.

Three-part test: Duty of Care

(1) act in good faith,

(2) act with the care of an objectively prudent person, and

(3) act in a way reasonably calculated to advance the corporation's best interests.

Breaches of the duty of care

NEGLIGENCE (not reading reports or skipping meetings),

FAILURE TO ACT WITH DILIGENCE (not investigating suspicious activity, e.g., via a CPA/attorney), and

RUBBER-STAMPING (approving without independent judgment). Directors CAN reasonably rely on officers'/experts' reports they reasonably believe to be reliable.

RUBBER-STAMPING

Approving transactions without determining whether they're prudent and in the corporation's best interest.

Reliance

A director may rely on opinions, reports, and financial records presented by officers/experts the director "reasonably believes... to be reliable and competent in these matters" — so they don't have to personally verify everything.

Duty of loyalty

Requiring insiders to put the corporation's interests ahead of their own.

Self-dealing

When an insider has a personal financial stake in a corporate transaction AND helps push it forward. It is NOT automatically a breach of loyalty: under the RMBCA it's fine if a majority of DISINTERESTED parties approve it after the insider DISCLOSES the opportunity.

Corporate opportunity doctrine

Insiders may not "usurp" for themselves a business opportunity that belongs to, or would benefit, the corporation; they must disclose it first.

Corporate opportunity doctrine (Court analysis)

(1) Could the corporation realistically seize/develop it (reasonable-expectations test)?

(2) Is it fair to shareholders to let someone usurp it?

(3) Is it closely related to the corporation's business? If the board, after disclosure, rejects it, the insider is then free to pursue it.

Usurp

to seize an opportunity for oneself when it rightfully belongs to the corporation.

Business judgment rule

A protection that shields officers and directors from liability for honest decisions that turn out badly, as long as they didn't breach the duty of care. It insulates "unwise but informed" decisions so directors aren't punished for taking reasonable risks.

Business judgment rule — three hurdles to get protection

(1) NO PRIVATE INTEREST (no financial self-interest in the deal),

(2) BEST INFORMATION (stayed actively informed on the material facts), and

(3) RATIONAL BELIEF (the decision came from a reasoned, rational process). Courts focus on the PROCESS of decision-making, not the outcome.

Derivative action (derivative suit)

A lawsuit a shareholder brings IN THE NAME OF the corporation against an insider, usually for breach of fiduciary duty.

Derivative action requirment

the shareholder must FIRST make a formal demand on the board to fix the problem and give it time to act — only if the board refuses can the suit proceed.

Direct action

A lawsuit a shareholder brings ON THEIR OWN BEHALF, typically alleging oppression of minority shareholders, denial of voting rights, or denial of inspection rights.

Limiting director liability

In response to a wave of duty-of-care lawsuits, states protect directors three ways:

(1) let the corporate charter eliminate/reduce personal liability if the director acted in good faith; (2) raise the bar so only EGREGIOUS conduct triggers liability; and

(3) CAP the monetary damages recoverable from a director or officer.

Merger

When two or more companies combine to form a NEW entity, and NONE of the original companies survives.

Acquisition (takeover)

The purchase of one company by another: the acquiring corporation "steps into the shoes" of the target, and the target disappears by operation of law. Can be a purchase of stock OR assets, and private OR public.

Corporate formalities

The ongoing legal housekeeping a corporation must do: hold shareholder/director meetings, file annual reports, make disclosures, and keep corporate records and bylaws current. Why it matters: skipping formalities is one of the factors that lets courts PIERCE the corporate veil and reach owners' personal assets.

CASE 15.4 — Florence Cement Co. v. Vittraino

Facts: Shelby (a real estate developer managed by Essad) hired Florence for concrete/asphalt work, then ran out of assets and couldn't pay the ~$114,557 owed. Holding: the Michigan Court of Appeals REVERSED and pierced the corporate veil for Florence. Why: the principals treated their own liabilities as Shelby's and vice versa (no separation), intentionally undercapitalized Shelby into insolvency, and Essad FALSIFIED a sworn loan-draw statement to the bank (fraud). Takeaway: treating the corporation as your "alter ego" plus fraud is a recipe for losing veil protection.

Walkovsky v. Carlton (ethics example)

A pedestrian (Walkovsky) was injured by a taxicab; the owner (Carlton) had split his cab fleet across many corporations, each holding only one or two cabs with minimal insurance. The court REFUSED to pierce the veil and protected Carlton's personal assets, even though the structure existed mainly to cap liability. Raises the ethics question: is a legal structure that leaves injury victims with little remedy good for society?