E

Corporations: Structure, Governance, and Taxation

Corporations: A Detailed Study Guide

I. Introduction to Corporations

  • Necessity for Corporations: Sole proprietorships and partnerships have significant disadvantages, primarily unlimited liability where personal assets are at risk from business debts. Corporations provide a solution by offering limited liability to owners, coupled with flexibility and ease of management.

  • Example: Apple Computer and Steve Jobs

    • Steve Jobs, a college dropout, partnered with talented engineer Steve Wozniak to form Apple Computer in 1976. Its incorporation a year later allowed for significant operational flexibility.

    • Benefits of Incorporation for Apple:

      • Facilitated bringing in individuals with diverse skills and capabilities.

      • Enabled early-stage capital raising by offering shares.

      • Allowed Jobs to accumulate wealth through selling company stock (securities).

    • Insight from Steve Jobs: "Great things in business are never accomplished with just one person; they are accomplished with a team of people." Modern corporate products are a result of team effort, not individuals.

  • Definition of a Corporation: A corporation is a separate legal entity, distinct and apart from its owners. It possesses unique legal and constitutional rights.

  • Continuity of Existence: Corporations can be formed for a limited duration or have perpetual existence. Their operations remain undisturbed regardless of changes in ownership (shareholders), allowing companies to thrive long after their founders are gone or as shareholder identities change frequently.

II. Corporate Formation and Legal Framework

  • State Law Governance: Corporate law is state law; there is no such thing as a "U.S. corporation." Corporations are incorporated by individual states.

  • Choice of Incorporation State: While most incorporate in their principal place of business, many companies choose Delaware.

    • Delaware's Advantages:

      • Reputation: Known for fairly and quickly applying a very well-developed body of corporate law.

      • Court System: Chancery courts operate without a jury, leading to predictable, transparent disputes with well-reasoned judicial opinions.

  • Incorporation Process:

    • Business founders must apply to their respective state agencies (typically within the Secretary of State) to start their companies, a process that can be surprisingly quick, easy, and inexpensive.

    • Key Requirement: Articles of Incorporation: Founders must file these with the state agency. While varying by state, common requirements include:

      • Company Name: Must be unique and distinctive, usually including terms like "Incorporated," "Company," "Corporation," or "Limited."

      • Profit Status: Stating whether the company is for-profit or nonprofit.

      • Founder Identity.

      • Duration: How long the company is intended to exist.

      • Purpose: Under older common law, ultra vires lawsuits (for actions beyond stated scope) were possible, but modern statutes often permit stating the corporation can carry out "any lawful actions," rendering such lawsuits largely obsolete in the U.S.

      • Share Structure: Stating the initial number of shares to be issued and their par value.

III. Corporate Management and Maintenance

  • Complexity and Expertise Required: Unlike sole proprietorships, corporations are complex to manage and typically necessitate the services of attorneys and accountants to maintain corporate books properly.

  • Ongoing Annual Maintenance: Beyond initial filing fees, corporations incur annual expenses such as:

    • License fees.

    • Franchise fees and taxes.

    • Attorney fees.

    • Costs related to maintaining minute books, corporate seals, stock certificates, and registries.

    • Out-of-state registration fees.

  • Domestic vs. Foreign Corporations:

    • A domestic corporation operates in its state of incorporation.

    • To conduct business outside its state of incorporation, it must register as a foreign corporation, highlighting the potential expense and unwieldiness of maintaining operations across multiple states.

IV. Shareholders: Ownership and Limited Liability

  • Role of Shareholders: Owners of corporations. Their numbers can range from a single shareholder to millions.

  • Types of Corporations by Shareholder Count:

    • Closely Held Corporation: Characterized by a small number of shareholders.

    • Publicly Traded Corporation: Features a large body of shareholders, with share value determined by market supply and demand.

  • Ownership Rights vs. Asset Rights: Shareholders own shares or stock in the company, but they have no legal right whatsoever to the company's assets. As a separate legal entity, the corporation owns its own property.

  • Limited Liability - A Core Advantage:

    • Shareholders' maximum financial risk is limited to the amount of their investment (the price paid for shares).

    • In cases of bankruptcy or inability to pay debts, shareholders lose the value of their stock, but their personal assets (e.g., homes, bank accounts) are protected and unreachable by creditors.

  • Shareholder Demographics: Shareholders can be individuals or other legal entities like partnerships or other corporations.

    • Parent Company: A corporation that owns all the stock of another corporation.

    • Wholly Owned Subsidiary: The company completely owned by a parent company.

    • Affiliate: A company in which a parent company owns a stake, but not all of its stock.

  • Strategic Use of Subsidiaries: Large corporations often form subsidiaries for specific purposes to gain advantages:

    • Limited Liability: For instance, a real property subsidiary can isolate premises liability to just that entity, shielding the parent company's assets from tort lawsuits.

    • Tax Advantages: Intellectual property subsidiaries can license IP back to the parent, allowing the parent to deduct royalty payments from taxes.

  • Illustrative Example: General Motors Restructuring (2009)

    • Facing collapse, the old General Motors Corporation restructured by forming a new entity, General Motors Company ("new GM").

    • Old GM (renamed Motors Liquidation Company): Entered bankruptcy, cancelled costly contracts, its stock became worthless, and it retained undesirable liabilities (obsolete assets, unpaid claims).

    • New GM: Received all of GM's valuable assets, including surviving brands (Cadillac, Chevrolet, Buick, GMC), plants, and shares in key domestic and foreign subsidiaries.

    • The U.S. federal government became the majority shareholder of the new GM.

    • Legally, the old and new GMs are entirely separate and distinct entities.

V. Corporate Governance: Piercing the Veil, Shareholder Classes & Rights

  • Piercing the Corporate Veil (Exception to Limited Liability):

    • Primarily occurs in closely held corporations when owners (e.g., sole proprietors who incorporated) fail to respect the corporation as a separate legal entity.

    • Cause: Commingling personal and business finances (e.g., using a business bank account for personal expenses).

    • Effect: Creditors can petition a court to "pierce the corporate veil," which removes limited liability and allows creditors to access the shareholder's personal assets. The argument is that the corporate form is a