1. © 2004 West Legal Studies in Business A Division of Thomson Learning 1 Chapter 37 Corporations – Formation and Financing Chapter 37 Corporations – Formation and Financing

2. © 2004 West Legal Studies in Business A Division of Thomson Learning 2 § 1: The Nature of the Corporation A corporation is a creature of statute, an artificial “person.”  Most states follow the Model Business Corporation Act (MBCA) or the RMBCA, that are model corporation laws. The shares (stock) of a corporation are owned by at least one shareholder (stockholder). A corporation is a creature of statute, an artificial “person.”  Most states follow the Model Business Corporation Act (MBCA) or the RMBCA, that are model corporation laws. The shares (stock) of a corporation are owned by at least one shareholder (stockholder).

3. © 2004 West Legal Studies in Business A Division of Thomson Learning 3 Nature of the Corporation [2] The corporation substitutes itself for the natural persons in conducting corporate business and incurring liability, but its authority and liability are separate and apart from the shareholders. In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable. The corporation substitutes itself for the natural persons in conducting corporate business and incurring liability, but its authority and liability are separate and apart from the shareholders. In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable.

4. © 2004 West Legal Studies in Business A Division of Thomson Learning 4 Corporate Personnel Individual shareholders own corporation. Shareholders elect board of directors to manage corporation. Board of directors hires officers to run corporation on a daily basis. Individual shareholders own corporation. Shareholders elect board of directors to manage corporation. Board of directors hires officers to run corporation on a daily basis.

5. © 2004 West Legal Studies in Business A Division of Thomson Learning 5 Corporate Personnel [2] Body of shareholders can change constantly without affecting the continued existence of the corporation. Shareholder can sue corporation and be sued by corporation and bring suit for corporation in some instances (derivative action). Body of shareholders can change constantly without affecting the continued existence of the corporation. Shareholder can sue corporation and be sued by corporation and bring suit for corporation in some instances (derivative action).

6. © 2004 West Legal Studies in Business A Division of Thomson Learning 6 Corporate Taxation Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. Corporate profits are taxed under federal and state law as a separate “person” from its shareholders. Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level. Case 37.1: Bullington v. Palangio (2001). Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. Corporate profits are taxed under federal and state law as a separate “person” from its shareholders. Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level. Case 37.1: Bullington v. Palangio (2001).

7. © 2004 West Legal Studies in Business A Division of Thomson Learning 7 Constitutional Rights of Corporations [1] A corporation is an artificial “person” and has constitutional rights to:  Equal protection;  Access to the courts, can sue and be sued;  Right to due process before denial of life, liability or property. A corporation is an artificial “person” and has constitutional rights to:  Equal protection;  Access to the courts, can sue and be sued;  Right to due process before denial of life, liability or property.

8. © 2004 West Legal Studies in Business A Division of Thomson Learning 8 Constitutional Rights of Corporations [2] Corporation’s rights (cont’d):  Freedom from unreasonable search and seizure and double jeopardy.  Freedom of speech. Only officers and directors have protection against self- incrimination.  However, corporations do not have full protection of privileges and immunities clause. Corporation’s rights (cont’d):  Freedom from unreasonable search and seizure and double jeopardy.  Freedom of speech. Only officers and directors have protection against self- incrimination.  However, corporations do not have full protection of privileges and immunities clause.

9. © 2004 West Legal Studies in Business A Division of Thomson Learning 9 Torts and Criminal Acts A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior. Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison. A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior. Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison.

10. © 2004 West Legal Studies in Business A Division of Thomson Learning 10 Corporate Sentencing Guidelines Federal Organizational Corporate Sentencing Guidelines provide specific sentencing guidelines for crimes committed by corporate employees (white collar crime).  32 levels of offenses: Culpability score. Credits can be applied. Federal Organizational Corporate Sentencing Guidelines provide specific sentencing guidelines for crimes committed by corporate employees (white collar crime).  32 levels of offenses: Culpability score. Credits can be applied.

11. © 2004 West Legal Studies in Business A Division of Thomson Learning 11 § 2: Corporate Powers A corporation may act and enter into contracts as any natural person, except as limited by:  U.S. Constitution.  State constitutions.  State statutes.  Its own articles of incorporation.  Its own corporate bylaws.  Resolutions by its own board. A corporation may act and enter into contracts as any natural person, except as limited by:  U.S. Constitution.  State constitutions.  State statutes.  Its own articles of incorporation.  Its own corporate bylaws.  Resolutions by its own board.

12. © 2004 West Legal Studies in Business A Division of Thomson Learning 12 Express Powers The express powers of a corporation are found in the corporation’s articles of incorporation, the laws of the state of incorporation, and in the state and federal corporations. Corporate by-laws may also grant or limit a corporation’s express powers. The express powers of a corporation are found in the corporation’s articles of incorporation, the laws of the state of incorporation, and in the state and federal corporations. Corporate by-laws may also grant or limit a corporation’s express powers.

13. © 2004 West Legal Studies in Business A Division of Thomson Learning 13 Implied Corporate Powers Corporation has implied powers to: to perform all acts reasonably necessary to accomplish its corporate purposes, e.g.,: Borrow and lend money. Extend credit. Make charitable contributions. A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise. Corporation has implied powers to: to perform all acts reasonably necessary to accomplish its corporate purposes, e.g.,: Borrow and lend money. Extend credit. Make charitable contributions. A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise.

14. © 2004 West Legal Studies in Business A Division of Thomson Learning 14 Ultra Vires Doctrine Corporate acts are beyond the express or implied powers of the corporation as stated in state statute or the corporation’s own articles of incorporations and are considered to be “ultra vires” (beyond the powers). Corporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation. Corporate acts are beyond the express or implied powers of the corporation as stated in state statute or the corporation’s own articles of incorporations and are considered to be “ultra vires” (beyond the powers). Corporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation.

15. © 2004 West Legal Studies in Business A Division of Thomson Learning 15 Ultra Vires Doctrine [2] The Following remedies are available for ultra vires acts:  Shareholders can bring action for corporation.  Corporation can recover damages from its officers and directors.  Attorney general of state may bring action to dissolve corporation for ultra vires acts. The Following remedies are available for ultra vires acts:  Shareholders can bring action for corporation.  Corporation can recover damages from its officers and directors.  Attorney general of state may bring action to dissolve corporation for ultra vires acts.

16. © 2004 West Legal Studies in Business A Division of Thomson Learning 16 § 3: Classification of Corporations Domestic corporation does business in its state of incorporation. Foreign corporation from X state doing business in Z state. Alien Corporation: formed in another country doing business in United States. Domestic corporation does business in its state of incorporation. Foreign corporation from X state doing business in Z state. Alien Corporation: formed in another country doing business in United States.

17. © 2004 West Legal Studies in Business A Division of Thomson Learning 17 Classification of Corporations [2] Public and Private. Nonprofit. Close Corporations.  Shares held by few shareholders.  More informal management,similar to a partnership.  Restriction on transfer of shares.  Case 34.2: Crowder Construction v. Kiser (1999). Public and Private. Nonprofit. Close Corporations.  Shares held by few shareholders.  More informal management,similar to a partnership.  Restriction on transfer of shares.  Case 34.2: Crowder Construction v. Kiser (1999).

18. © 2004 West Legal Studies in Business A Division of Thomson Learning 18 Classification of Corporations [3] “S Corporations”: Avoids the federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. IRS requirements:  Corporation is domestic, fewer than 75 shareholders, only one class of stock, no shareholder can be a non- resident alien. Professional Corporations. “S Corporations”: Avoids the federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. IRS requirements:  Corporation is domestic, fewer than 75 shareholders, only one class of stock, no shareholder can be a non- resident alien. Professional Corporations.

19. © 2004 West Legal Studies in Business A Division of Thomson Learning 19 § 4: Corporate Formation The process of incorporation generally involves two steps:  Preliminary and Promotional Activities; and  The Legal Process of Incorporation. The process of incorporation generally involves two steps:  Preliminary and Promotional Activities; and  The Legal Process of Incorporation.

20. © 2004 West Legal Studies in Business A Division of Thomson Learning 20 Incorporation Process Promotion Name Search File Articles of Incorporation Subscribers 1st Organiza- tional Meeting State Charter

21. © 2004 West Legal Studies in Business A Division of Thomson Learning 21 Promotional Activities Before corporation is formed, promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements.

22. © 2004 West Legal Studies in Business A Division of Thomson Learning 22 Promoter’s Liabilities A Promoter (or corporation) can create a prospectus required by federal and state securities laws to inform and protect investors. Promoter is personally liable for pre- incorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable. A Promoter (or corporation) can create a prospectus required by federal and state securities laws to inform and protect investors. Promoter is personally liable for pre- incorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable.

23. © 2004 West Legal Studies in Business A Division of Thomson Learning 23 Promoter’s Liabilities [2] After corporate formation, corporation can adopt the pre-incorporation contract and release the promoter by creating a “novation”. Subscribers and Subscription Agreements: continuing contracts to purchase stock. Generally, subscribers become stockholders upon corporate formation. After corporate formation, corporation can adopt the pre-incorporation contract and release the promoter by creating a “novation”. Subscribers and Subscription Agreements: continuing contracts to purchase stock. Generally, subscribers become stockholders upon corporate formation.

24. © 2004 West Legal Studies in Business A Division of Thomson Learning 24 Articles of Incorporation State Chartering:  Select state (some states such as Delaware cater to corporations http://www.state.de.us/corp/ ).http://www.state.de.us/corp/  Articles of Incorporation: primary enabling document filed with the Secretary of State that includes basic information about the corporation. Person(s) who execute the articles are the incorporators. See sample articles of incorporation at the Texas Secretary of State http://www.sos.state.tx.us/corp/forms.shtmlhttp://www.sos.state.tx.us/corp/forms.shtml State Chartering:  Select state (some states such as Delaware cater to corporations http://www.state.de.us/corp/ ).http://www.state.de.us/corp/  Articles of Incorporation: primary enabling document filed with the Secretary of State that includes basic information about the corporation. Person(s) who execute the articles are the incorporators. See sample articles of incorporation at the Texas Secretary of State http://www.sos.state.tx.us/corp/forms.shtmlhttp://www.sos.state.tx.us/corp/forms.shtml

25. © 2004 West Legal Studies in Business A Division of Thomson Learning 25 Articles of Incorporation [2] Choose and reserve a Corporate Name. Name must have the proper suffix: “Corporation,” “Corp.,” “Incorporated.” You should also consider registering the corporation as a “dot com” at networksolutions.com or register.com. networksolutions.comregister.com Choose and reserve a Corporate Name. Name must have the proper suffix: “Corporation,” “Corp.,” “Incorporated.” You should also consider registering the corporation as a “dot com” at networksolutions.com or register.com. networksolutions.comregister.com

26. © 2004 West Legal Studies in Business A Division of Thomson Learning 26 Articles of Incorporation [3] Purpose: trend towards “any legal business.” Duration: usually perpetual. Capital Structure: Most states require some minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation. Purpose: trend towards “any legal business.” Duration: usually perpetual. Capital Structure: Most states require some minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation.

27. © 2004 West Legal Studies in Business A Division of Thomson Learning 27 Articles of Incorporation [4] Internal Organization: usually included in the bylaws. Registered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3 rd parties. Incorporators (usually the promoter): at least one with name and address. Internal Organization: usually included in the bylaws. Registered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3 rd parties. Incorporators (usually the promoter): at least one with name and address.

28. © 2004 West Legal Studies in Business A Division of Thomson Learning 28 First Organizational Meeting After the corporation is “chartered” (created) it can do business. Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities. After the corporation is “chartered” (created) it can do business. Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities.

29. © 2004 West Legal Studies in Business A Division of Thomson Learning 29 § 5: Improper Incorporation Errors in incorporation procedures when a 3 rd party seeks to bring an action against a corporation that may not have complied perfectly with every incorporation law. Problematic for shareholders who may be personally liable. In addition, entity may not be able to enforce contracts. Errors in incorporation procedures when a 3 rd party seeks to bring an action against a corporation that may not have complied perfectly with every incorporation law. Problematic for shareholders who may be personally liable. In addition, entity may not be able to enforce contracts.

30. © 2004 West Legal Studies in Business A Division of Thomson Learning 30 Improper Incorporation De Jure: substantial statutory requirements are met; cannot be attacked by state or 3 rd parties. De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law;corporate status can only be attacked by state. By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. De Jure: substantial statutory requirements are met; cannot be attacked by state or 3 rd parties. De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law;corporate status can only be attacked by state. By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists.

31. © 2004 West Legal Studies in Business A Division of Thomson Learning 31 § 6: Disregarding the Corporate Entity “ Piercing the Corporate Veil” occurs when a court, in the interest of justice or fairness,” holds shareholders personally liable for corporate acts. Court concludes that shareholders used corporation as a “shield” from illegal activity. “ Piercing the Corporate Veil” occurs when a court, in the interest of justice or fairness,” holds shareholders personally liable for corporate acts. Court concludes that shareholders used corporation as a “shield” from illegal activity.

32. © 2004 West Legal Studies in Business A Division of Thomson Learning 32 Piercing the Corporate Veil Factors a court considers:  3 rd party tricked into dealing with a corporation rather than the individual.  Corporation is set up never to make a profit or remain insolvent or is under capitalized.  Statutory formalities are not followed. Factors a court considers:  3 rd party tricked into dealing with a corporation rather than the individual.  Corporation is set up never to make a profit or remain insolvent or is under capitalized.  Statutory formalities are not followed.

33. © 2004 West Legal Studies in Business A Division of Thomson Learning 33 Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. Case 37.3: Dimmitt & Owens Financial, Inc. v. Superior Sports Products, Inc. (2002). Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. Case 37.3: Dimmitt & Owens Financial, Inc. v. Superior Sports Products, Inc. (2002). Piercing the Corporate Veil

34. © 2004 West Legal Studies in Business A Division of Thomson Learning 34 § 7: Corporate Financing Bonds v. Stocks  DebtOwnership/equity  Fixed ROI Dividends (variable)  No votesVote for Management  OptionalRequired  Priority over stockPaid last Stocks: Common vs. Preferred Bonds v. Stocks  DebtOwnership/equity  Fixed ROI Dividends (variable)  No votesVote for Management  OptionalRequired  Priority over stockPaid last Stocks: Common vs. Preferred

35. © 2004 West Legal Studies in Business A Division of Thomson Learning 35 Bonds TypeDefinition DebenturesNo specific corporate assets are pledged as collateral. Backed by corporation’s general credit rating. MortgagesPledge specific real estate. If corporation defaults, bondholders can foreclose. ConvertibleConditions trigger bonds to convert to corporate stock. CallableCan be “called in” by principal and repaid according to bond conditions.

36. © 2004 West Legal Studies in Business A Division of Thomson Learning 36 Stocks Common Stock: represents true ownership of a corporation. Provides pro-rata (proportional) ownership interest reflected in control, earnings and assets. Preferred Stock: has preferences over common stock.  Cumulative Preferred.  Participating Preferred.  Convertible Preferred.  Redeemable or Callable Preferred. Common Stock: represents true ownership of a corporation. Provides pro-rata (proportional) ownership interest reflected in control, earnings and assets. Preferred Stock: has preferences over common stock.  Cumulative Preferred.  Participating Preferred.  Convertible Preferred.  Redeemable or Callable Preferred.

37. © 2004 West Legal Studies in Business A Division of Thomson Learning 37 Law on the Web State Corporation Statutes at Cornell U. State Corporation Statutes The Texas Business Corporation Act. The Texas Business Corporation Act Center for Corporate Law at Cincinnati U College of Law. Center for Corporate Law at Cincinnati U College of Law FAQ’s on incorporation at Bizfilings.com Legal Research Exercises on the Web. State Corporation Statutes at Cornell U. State Corporation Statutes The Texas Business Corporation Act. The Texas Business Corporation Act Center for Corporate Law at Cincinnati U College of Law. Center for Corporate Law at Cincinnati U College of Law FAQ’s on incorporation at Bizfilings.com Legal Research Exercises on the Web.