Chapter 18: Corporations -Corporations

Chapter 18: Corporations - Nature and Classification

Definition and Characteristics of a Corporation

• Legal Entity: A corporation is a legal entity distinct from its owners.

• Statutory Requirements: Formation of a corporation requires following formal statutory requirements, which vary by state.

• Artificial Person: Under U.S. law, a corporation is recognized as an artificial legal person enjoying the same rights as U.S. citizens.

Corporate Personnel and Structure

• Shareholders:

  • Owners of the corporation.

  • Their liability is limited to the amount of their investments.

  • They elect a board of directors to govern the corporation.

  • The board of directors hires corporate officers and other employees to run daily operations.

Advantages of Corporations

• Limited Liability: Shareholders' liability is limited to their investment in the corporation.

Corporate Taxation

• The corporation is taxed on net profits; shareholders are taxed on disbursed dividends (double taxation feature).

Liability for Torts and Crimes

• Corporations are liable for torts committed by agents or officers within the course and scope of employment (doctrine of respondent superior).

• Corporations can also be held liable for the criminal acts of agents and employees.

Types of Corporations

• Domestic Corporation: Incorporated in its home state.

• Foreign Corporation: Any state outside its home state.

• Alien Corporation: Corporations originating in another country doing business in the U.S.

• Public Corporation: Formed by a government for public benefit (e.g., cities).

• Private Corporation: Formed for private benefit; most corporations fall under this category.

• Nonprofit Corporations: Established without a profit-making purpose.

• Close Corporations: Owned by a relatively small number of individuals, often family members, with share transfer restrictions.

• S Corporations: Small domestic corporations with special tax treatment under subchapter S of the Internal Revenue Code.

  • Requirements include: no more than 100 shareholders, one class of stock, shareholders must be individuals/estates/trusts, must be domestic.

• Professional Corporations: Formed by professionals (e.g., physicians, lawyers) where some courts may treat shareholders as partners for liability purposes.

• Benefit Corporations: Aim to benefit the public and have positive societal and environmental impacts.

  • Characterized by purpose, accountability, and transparency.

Formation and Powers of Corporations

• Promotional Activities: Individuals who enter contracts on behalf of a future corporation are personally liable until the corporation officially assumes those contracts.

Incorporation Procedures

1. Select a State of Incorporation.

2. Secure an Appropriate Corporate Name.

3. Prepare Articles of Incorporation, which must include:

   • Corporate name.

   • Number of authorized shares.

   • Name and street address of the initial registered agent and office.

   • Name and address of each incorporator.

4. File Articles with Secretary of State: This grants authority to conduct business.

Initial Organizational Meeting

• Main function: adopt bylaws (internal rules) and conduct other business, including the election of the board of directors.

Types of Incorporation Statuses

• De Jure Corporation: Fully compliant with incorporation conditions.

• De Facto Corporation: Recognized despite defects if:

  1. A statute exists for incorporation.

  2. Good faith attempts to comply with the statute.

  3. Business conducted as a corporation.

• Corporation by Estoppel: If a business represents itself as a corporation, it may be treated as such in legal actions despite not being legally incorporated.

Corporate Financing

• Financing Sources:

  • Bonds: Debt securities representing borrowed funds.

  • Stocks: Equity securities representing ownership.

  • Common Stock: True ownership with voting rights and profit share.

  • Preferred Stock: Has preferences over common stock.

  • Venture Capital: Investment from outside professionals in new ventures.

  • Private Equity Capital: Investment from private equity firms for purchasing and reorganizing existing corporations.

  • Crowdfunding: Collaborative funding through internet platforms for causes or business ventures.

Corporate Powers

• Express Powers: Found in articles of incorporation and laws of incorporation state.

• Implied Powers: Powers necessary to accomplish corporate purposes beyond express powers.

  • Ultra Vires Doctrine: Acts beyond express or implied powers; can lead to lawsuits by shareholders or attorneys general.

Piercing the Corporate Veil

• Occurs to enforce personal liability on shareholders to avoid injustice, e.g.:

  • Misleading parties into dealing with the corporation rather than individuals.

  • Corporations established for no profit or perpetual insolvency.

  • Avoiding an existing legal obligation.

  • Failure to follow statutory formalities.

  • Commingling of personal and corporate interests.

Directors and Officers

• Responsibilities:

  • Responsible for policymaking decisions.

  • Inside Directors: Officers of the corporation.

  • Outside Directors: Not holding a management position.

  • Elected by shareholders, usually serving a one-year term.

Corporate Governance Structure

• Executive Committee: Manages interim decisions between board meetings.

• Audit Committee: Required by Sarbanes-Oxley Act for publicly held corporations; selects independent public accountants.

Rights and Duties of Directors and Officers

• Duty of Care:

  • Act in good faith and exercise ordinary care.

  • Make informed and reasonable decisions.

  • Supervise reasonably.

  • When the rule applies:

  • 1. director/officer took reasonable steps to become informed about the matter

  • 2. had a rational basis for decision

  • 3. no conflict of interest between personal interest and that of the corporation

    • Provides broad protections because most courts will apply the rule unless evidence of bad faith, fraud, or clear breach of fiduciary duties

• Business Judgment Rule: Protects directors from liability for honest mistakes in judgment if made in good faith.

• Duty of Loyalty: A fiduciary duty to prioritize corporate interests over personal ones, including:

  • Competing with the corporation.

  • Usurping corporate opportunities.

  • Conflicts of interest.

  • Insider trading.

  • Detrimental corporate transactions to minority shareholders.

  • Selling control over the corporation.

Conflicts of Interest

• Directors and officers must disclose potential conflicts between personal interests and corporate interests.

Liability of Directors and Officers

• They are liable for personal crimes and torts, and may also be liable for actions of supervised employees.

Shareholders

• Powers:

  • Approve all fundamental changes.

  • Elect or remove board members.

Shareholders Meetings

• Must occur at least annually.

• Special meetings can be called with notice sent to shareholders regarding date, time, and purpose.

• Voting procedures include quorum requirements (minimum # of shareholders) and may allow voting by proxy.

Shareholder Rights

• Stock Certificate: Evidence of ownership in shares.

• Preemptive Rights: Right to purchase new stock in proportion to existing holdings.

• Dividends: Distribution of profits based on share ownership; illegal dividends can arise if not properly declared or if insolvency occurs.

• Inspection Rights: Right to examine corporate records for proper purposes.

• Transfer of Shares: Generally permissible unless restricted.

• Rights on Dissolution and Suits against third parties (derivative suits).

  • written demand is required; damages recovered normally go into the corporations treasury

• Duties of Majority Shareholders: May have fiduciary duties to minority shareholders to prevent oppressive conduct.

• Watered Stock: Shares issued for less than their stated value, compromising corporation integrity.