business law for entrepreneurs - chapter 30: corporations

Corporation

a fictitious legal entity that exists as an independent individual separate from its principals

Business corporation law

each state has specific law that covers such matters as the structure of the corporation, oversight of the activity of the corporation’s managers, rights of the principals in the case of the sale of assets or ownership interests, annual reporting requirements, and other issues that affect the internal rules of the business venture

Revised Model Business Corporation Act (RMBCA)

privately held corporations

corporations owned exclusively by a group of private individuals. Have substantial flexibility regarding their internal operating procedures and do not generally have to comply with rigorous corporate structures or formalities

publicly held corporations

corporations that sell their ownership interest via public stock exchanges

Closely held or family-held (for privately held corporations)

further restricts number or type of owners that a corporation may have, but gives even more flexibility on how business venture may be organized and managed

Other categories of corporations

Domestic - within own state of incorporation

Foreign - when a corporation transacts business in a state other than its state of incorporation

Alien - a corporation formed outside US that transacts business in US

Nonprofit - no profit-seeking owners, they exist to perform some service to public at large

Benefit - for-profit corporate entities that align business objectives w/ societal objectives

Public - formed by government body to serve public at large (ex. public mass transmit companies); have no owners

Professional - ownership is restricted to a particular profession licensed in that field

Articles of incorporation

document to form a corporation that must be filed with state authority; sets out corporation’s name, purpose, number of shares issued, and address of corporation’s headquarters; sets in motion the incorporation process

Promoter

individual or group of individuals who beings to carry out a business venture’s activities before actually filing the articles of incorporation - could include arranging for necessary capital thru a loan, recruiting personnel, leasing property, and arranging to have the business incorporated. if they make contract on behalf of non-yet-formed corporation, could have some personal liability to perform under the contract (liability ceases though at the moment the corporation is formed and has adopted the contract)

Case: Branch v. Mullineaux et al., 2010 N.Y. slip op. 31850(U), Supreme Court of New York County

The New York court held in favor of Branch. The court ruled that because the agreement was executed prior to formation of the entity, MGS created individual liability to Branch. MGS were liable as individuals because promoters who execute pre incorporation contracts in the name of a proposed corporation are personally liable on the contract unless the parties have agreed otherwise. In this case, it was undisputed that the corporate entity did not exist at the time that the agreement was entered into. Thus, as pre incorporation promoters, MGS were personally liable for the agreement executed prior to the incorporation of an entity, even if the entity would otherwise be considered the contracting party

S corporation taxation

flow-through/pass-through - not subject to taxation at entity level. the taxable income or loss of business operated by the entity flows through to the entity’s shareholders, offering investors numerous tax benefits

Bylaws

typically specify date/time/place for shareholder meetings, number of officers and directors of corporation, process for electing board of directors, and listing of each officer along w/ description of officer’s duties. don’t have to be public but kept in corporate records

Also set procedures and requirements for an election of directors: time and date, notification to shareholders, how many shareholders must be present to hold a vote, and number of directors

Bonds

(for financing a corporation) debt money issued by a corporation to the general public with promises to pay the bondholders back at a specified rate of interest for a specified length of time and to repay the entire loan upon expiration of the bond (known as the maturity date)

Debentures

(for financing a corporation) function essentially the same as bonds but instead of being secured by some specified pledged piece of property, are issued on the strength of the general credit of the corporation

Venture capital

funding provided by a group of professional investors for use in a developing business - these firms are frequently focused on one industry, ex. healthcare or high-tech. Major advantage is these firms often have substantial resources and are a source of expertise in operations and expansion of the corporation, but they usually insist on substantial control over the corporation via its board of directors and even officers

Exit strategy (for venture capitalists)

venture capital firm exits corporation w/ substantial return - maybe taking company public through IPO or getting company to grow to point where a competitor would be willing to pay a substantial premium to purchase the corporation

Corporate veil

limited liability protection for personal assets of owners and (with certain exceptions) for officers and directors; shareholders, directors, and officers are generally insulated from personal liability in case the corporation runs up large debts or suffers some liability

Piercing the corporate veil

a court may hold some or all shareholders personally liable for corporate if at least 2 of 4 factors are present (though courts are always reluctant) - inadequate capitalization, nature of the claim, evidence of fraud or wrongdoing, failing to follow corporate formalities

Case: Trefoil Park v. Key Holdings et al., Civil Action: 3:14-CV-00364 (Dist. Ct., Conn. 2016)

The US District Court granted summary judgment in favor of Key. The court ruled that piercing the corporate veil was an extreme remedy to be used only when an entity was an instrumentality used to perpetrate injustice or fraud. In this case, there was no evidence that Hamlin or Levine had complete control over Key or that the entity was merely an undercapitalized shell. The court rejected Trefoil’s theory that any verbal representations about the financial viability of a privately held entity, such as Key, were sufficient to prove that the entity was created to defraud an investor or creditor. The court pointed out that (1) Hamlin and Levine invested and lost nearly $450k in Key in Total, (2) Key adhered to all corporate formalities, and (3) neither Hamlin nor Levine removed funds for personal use or intermingled Key funds with their personal funds.

Case: De Lage Landen Financial Services v. Picasso Aesthetic and Cosmetic Dental Spa, Civil Action N. 14-2240 (E.D. Pa. 2015)

The US District Court ordered summary judgment in favor of De Lage. In its decision, the court rejected Rubin’s attempts to connect the repossession and sale of the equipment with De Lage’s contractual right to seek funds from Rubin’s personal assets if Picasso failed to pay. Once Picasso failed to make payments and failed to cure its default, De Lage had the contractual right to a judgment for all sums owed under the loan agreement and the finance agreement against both Picasso’s assets and Rubin’s personal assets.

Shareholders

the owners of the corporation, act principally through electing and removing directors at shareholder meetings and approving or withholding approval of major corporate decisions (ex. sale of substantial assets, mergers, issuing more capital stock, pursuing venture capital financing, and issuing bonds); must approve any charges in the structure of the corporation by amending articles of incorporation or bylaws

Directors

responsible for oversight and management of corporation’s course of direction; sets the strategy and policies of the corporation. Most planning initiatives that result in a change to the corporation (ex. acquisition of another corporation’s assets or stock) are overseen by board prior to submitting plan to shareholders for approval

Officers

carry out the directors’ set course of business through management of the day-to-day operations of the business, and execute the strategy and mandates set out by the board of directors. Work closely w/ directors in setting course of corporation’s path, but major changes in the corporation may not be taken thru officer action alone. Have both express and implied authority

Quorum requirement

how many shareholders must be present to hold a vote (set in bylaws)

Committees

small groups of board members who are charged with oversight or to perform a given task and make a recommendation to the full board (ex. compensation committee, audit committee, election committee)

Express authority (of officers)

comes from the bylaws or by a board of directors’ resolution, which gives specific authority to a particular officer

Inherent authority

officers can have this authority based on their position to act on behalf of the corporation

Implied authority

certain corporate officers have this authority to be agents of the corporation

President (officer)

has implied power to bind the corporation in ordinary business operation transactions and has oversight of nonofficer employees

Vice president (officer)

has some limited implied authority, depending on size and scope of corporation

Treasurer (officer)

has little or no other implied authority, aside from routine tasks of collecting the accounts receivable and paying the accounts payable

Secretary (officer)

has implied authority to certify the records and resolutions of the company

Business judgment rule

a protection for officers and directors from liability when they have acted in good faith but still made an unwise decision that resulted in some loss to the corporation (without breaching duty of care)

To obtain protection of this rule: no private interest, best information, and rational belief

Landmark Case 30.4: Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)

The Delaware Supreme Court ruled against the directors, holding that they could not be afforded the protection of the business judgment rule. The court’s decision was primarily based on its conclusion that the directors had failed to obtain all material information and had neglected to investigate the transaction. The court pointed to the fact that the board never even reviewed the Van Gorkom-Pritzker agreement, nor had they undertaken anything more than a cursory inquiry into the actual value of the corporation.

Self-dealing

when an officer, director, or controlling shareholder has some personal financial state in a transaction that the corporation is engaged in and the officer, director, or shareholder helps to influence the advancement of the transaction

Duty of loyalty

requires disclosure and good faith when an insider (that is, a director, an officer, or a controlling shareholder) learns of a potentially lucrative business opportunity that could enrich them individually but is related to the corporation’s business

Case: Advantage Marketing Group, Inc. v. Keane, 143 N.E. 3d 139 (2019)

The Appellate Court of Illinois reversed the decision of the trial court and ruled that AMG had the right to go to trial on their claim that Keane breached the corporate opportunity doctrine. The court reasoned that even if Keane is not considered to be an officer or director of AMG, his considerable duties and responsibilities as an employee, his compensation, and his status as a minority shareholder put him in the position to act solely for the benefit of AMG in all matters connected with his position in the company. The court also found that the existence of a corporate opportunity, namely, the acquisition of The Mail House, a competing business was realistic because The Mail House was in the same line of business as AMG because it provided comparable products and services to the same clientele as AMG.