Business Law and the Regulation of Business Chapter 35: Financial Structure of Corporations By Richard A. Mann & Barry S. Roberts

Topics Covered in this Chapter I.Debt Securities A. Authority to Issue Debt Securities B. Types of Debt Securities II.Equity Securities A. Issuance of Shares B. Classes of Shares III. Dividends and Other Distributions A. Types of Dividends and Other Distributions B. Legal Restrictions on Dividends & Other Distributions C. Declaration and Payment of Distributions D. Liability for Improper Dividends & Distributions

Authority to Issue Debt Securities n Debt Security – source of capital creating no ownership interest and involving the corporation's promise to repay funds lent to it. n Bond – a debt security. n Rule – each corporation has the power to issue debt securities as determined by the board of directors.

Types of Debt Securities n Unsecured Bonds – called debentures; have only the obligation of the corporation behind them. n Secured Bonds – are claims against a corporation's general assets and also liens on specific property. n Income Bonds – condition to some extent the payment of interest on corporate earnings.

Types of Debt Securities n Participating Bonds – call for a stated percentage of return regardless of earnings, with additional payments dependent upon earnings. n Convertible Bonds – may be exchanged for other securities. n Callable Bonds – bonds subject to redemption.

Issuance of Shares n Equity Security – source of capital creating an ownership interest in the corporation. n Share – a proportionate ownership interest in a corporation. n Treasury Stock – shares reacquired by a corporation. n Authority to Issue – only those shares authorized in the articles of incorporation may be issued.

Debt and Equity Securities

Issuance of Shares n Preemptive Rights – right to purchase a pro rata share of new stock offerings. n Amount of Consideration for Shares – shares are deemed fully paid when a corporation receives the price set by the board of directors. n Payment for Newly Issued Shares – may be cash, property, and services actually rendered; under the Revised Act, promises to contribute cash, property, or services are also permitted.

Issuance of Shares Authorized But Not Issued Treasury Issued Authorized VOID Outstanding

Valid Capital Contributions KindULPARULPAMBCARMBCA CashYes PropertyYes Services renderedNoYes Promise to contribute cashNoYesNoYes Promise to contribute propertyNoYesNoYes Promise to perform servicesNoYesNoYes

Classes of Shares n Common Stock – stock not having any special contract rights. n Preferred Stock – stock having contractual rights superior to those of common stock. –Dividend Preferences – must receive full dividends before any dividend may be paid on common stock. –Liquidation Preferences – priority over common stock in corporate assets upon liquidation. –Stock Options – contractual right to purchase stock from a corporation. –

Types of Dividends and Other Distributions n Distributions – transfers of property by a corporation to any of its shareholders with respect to its shares. n Cash Dividends – the most common type of distribution. n Property Dividends – distribution in form of property. n Stock Dividends – a ratable distribution of additional shares of stock.

Types of Dividends and Other Distributions n Stock Splits – each of the outstanding shares is broken into a greater number of shares. n Liquidating Dividends – a distribution of capital assets to shareholders. n Redemption of Shares – a corporation's exercise of the right to purchase its own shares. n Acquisition of Shares – a corporation's repurchase of its own shares.

Legal Restrictions n Legal Restrictions on Cash Dividends – dividends may be paid only if the following tests are satisfied: –Cash Flow Test – a corporation must not be or become insolvent (unable to pay its debts as they become due in the usual course of business). –Balance Sheet Test varies among the States and includes the earned surplus test (available in all States), the surplus test, and the net assets test (used by the Model and Revised Acts).

Other Legal Restrictions n Legal Restrictions on Liquidating Distributions – States usually permit distribution in partial liquidation from capital surplus unless the company is insolvent. n Legal Restrictions on Redemptions of Shares – in most States, a corporation may not redeem shares when insolvent or when such redemption would render it insolvent. n Legal Restrictions on Acquisition of Shares – restrictions similar to those on cash dividends usually apply.

Key Concepts in Legal Restrictions upon Distributions Liabilities (Liquidation Preferences) Stated Capital (contributed capital*) Capital Surplus (contributed capital in excess of par or stated value*) Earned Surplus (retained earnings*) Surplus Net Assets Total Assets *Accounting terminology

Declaration and Payment of Distributions n Shareholders' Right to Compel a Distribution – the declaration of distributions is within the discretion of the board of directors, and only rarely will a court substitute its business judgment for that of the board's. n Effect of Declaration – once properly declared, a distribution is considered a debt the corporation owes to the shareholders.

Liability for Improper Dividends and Distributions n Directors – the directors who assent to an improper dividend are liable for the unlawful amount of the dividend. n Shareholders – a shareholder must return illegal dividends if he knew of the illegality, if the dividend resulted from his fraud, or if the corporation is insolvent.

Liability for Improper Distributions