1. Copyright © 2004 by Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany BUSINESS LAW E-Commerce and Digital Law International Law and Ethics 5 th Edition by Henry R. Cheeseman Slides developed by Les Wiletzky Wiletzky and Associates, Puyallup, WA Chapter 35 Formation and Operation of Corporations Chapter 35 Formation and Operation of Corporations

2. 35 - 2Copyright © 2004 by Prentice-Hall. All rights reserved. Corporation A fictitious legal entity that is created according to statutory requirements.

3. 35 - 3Copyright © 2004 by Prentice-Hall. All rights reserved. Nature of the Corporation  Corporations can only be created pursuant to the laws of the state of incorporation.  Corporations Codes – State statutes that regulate the formation, operation, and dissolution of corporations.  The courts interpret state corporation statutes to decide individual corporate and shareholder disputes.

4. 35 - 4Copyright © 2004 by Prentice-Hall. All rights reserved. The Corporation as a Legal “Person”  A corporation is a separate legal entity (or legal person).  Corporations are treated as artificial persons created by the state that can: Sue or be sued in their own names Sue or be sued in their own names Enter into and enforce contracts Enter into and enforce contracts Hold title to and transfer property Hold title to and transfer property Be found civilly and criminally liable for violations of law Be found civilly and criminally liable for violations of law

5. 35 - 5Copyright © 2004 by Prentice-Hall. All rights reserved. Characteristics of Corporations Limited Liability of Shareholders Free Transferability of Shares Perpetual Existence Centralized Management

6. 35 - 6Copyright © 2004 by Prentice-Hall. All rights reserved. Revised Model Business Corporation Act (RMBCA)  Model Business Corporation Act (MBCA) Model act drafted in 1950 Model act drafted in 1950 Was intended to provide a uniform law for regulation of corporations Was intended to provide a uniform law for regulation of corporations  Revised Model Business Corporation Act (RMBCA) 1984 revision of the MBCA 1984 revision of the MBCA Many states have adopted all or part of the RMBCA Many states have adopted all or part of the RMBCA

7. 35 - 7Copyright © 2004 by Prentice-Hall. All rights reserved. There is no general federal corporations law governing the formation and operation of private corporations. Many federal laws regulate the operation of private corporations.

8. 35 - 8Copyright © 2004 by Prentice-Hall. All rights reserved. Classifications of Corporations  Profit Corporation A corporation created to conduct a business for profit. A corporation created to conduct a business for profit. Can distribute profits to shareholders in the form of dividends. Can distribute profits to shareholders in the form of dividends.  Nonprofit Corporation A corporation that is formed to operate charitable institutions, colleges, universities, and other not-for-profit entities. A corporation that is formed to operate charitable institutions, colleges, universities, and other not-for-profit entities.

9. 35 - 9Copyright © 2004 by Prentice-Hall. All rights reserved. Classifications of Corporations (continued)  Public Corporation A corporation formed to meet a specific governmental or political purpose. A corporation formed to meet a specific governmental or political purpose.  Private Corporation A corporation formed to conduct privately owned business. A corporation formed to conduct privately owned business.  Professional Corporation A corporation formed by lawyers, doctors, or other professionals. A corporation formed by lawyers, doctors, or other professionals.

10. 35 - 10Copyright © 2004 by Prentice-Hall. All rights reserved. Classifications of Corporations (continued)  Publicly Held Corporation A corporation that has many shareholders. A corporation that has many shareholders. It’s securities are often traded on national stock exchanges. It’s securities are often traded on national stock exchanges.  Closely Held Corporation A corporation owned by one or a few shareholders. A corporation owned by one or a few shareholders.

11. 35 - 11Copyright © 2004 by Prentice-Hall. All rights reserved. Types of Corporations Type of Corporation DescriptionDomestic A corporation is a domestic corporation in the state in which it is incorporated Foreign A corporation is a foreign corporation in states other than the one in which it is incorporated Alien A corporation is an alien corporation in the United States if it is incorporated in another country.

12. 35 - 12Copyright © 2004 by Prentice-Hall. All rights reserved. Promoter  A person or persons who: Organize and start the corporation Organize and start the corporation Negotiate and enter into contracts in advance of its formation Negotiate and enter into contracts in advance of its formation Find the initial investors to finance the corporation Find the initial investors to finance the corporation

13. 35 - 13Copyright © 2004 by Prentice-Hall. All rights reserved. Promoters’ Liability  Promoters often enter into contracts on behalf of the corporation prior to its actual incorporation.  If the corporation never comes into existence, the promoters have joint personal liability on the contract unless the third party specifically exempts them from such liability.

14. 35 - 14Copyright © 2004 by Prentice-Hall. All rights reserved. Promoters’ Liability (continued)  If the corporation is formed, it becomes liable on a promoter’s contract only if it agrees to to become bound to the contract.  The promoter remains liable on the contract unless the parties enter into a novation.

15. 35 - 15Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation  Corporations are creatures of statute.  The organizers of the corporation must comply with the state’s incorporation statute to form a corporation.  A corporation can be incorporated in only one state even though it can do business in all other states in which it qualifies to do business.

16. 35 - 16Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation Procedures  Incorporator – The person or persons, partnerships, or corporations that are responsible for incorporation of a corporation.  Articles of Incorporation – The basic governing documents of the corporation. Must be filed with the secretary of state of the state of incorporation. Must be filed with the secretary of state of the state of incorporation. Can be amended to contain any provision that could have been lawfully included in the original document. Can be amended to contain any provision that could have been lawfully included in the original document.

17. 35 - 17Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation Procedures (continued)  Selecting a Corporate Name – Organizers must ensure that the name is not already in use and available.  General-Purpose Clause – A clause often included in the articles of incorporation that authorizes the corporation to engage in any activity permitted corporations by law.

18. 35 - 18Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation Procedures (continued)  Registered Agent – A person or corporation that is empowered to accept service of process on behalf of the corporation.  Corporate Bylaws – A detailed set of rules adopted by the board of directors after the corporation is incorporated. Contains provisions for managing the business and the affairs of the corporation. Contains provisions for managing the business and the affairs of the corporation.

19. 35 - 19Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation Procedures (continued)  Organizational Meeting – A meeting that must be held by the initial directors of the corporation after the articles of incorporation are filed.  Corporate Seal – A design containing the name of the corporation and the date of incorporation. It is imprinted by the corporate secretary using a metal stamp on certain legal documents. It is imprinted by the corporate secretary using a metal stamp on certain legal documents.

20. 35 - 20Copyright © 2004 by Prentice-Hall. All rights reserved. Incorporation Procedures (continued)  Corporate Status – The RMBCA provides that corporate existence begins when the articles of incorporation are filed. The filing of the articles of incorporation is conclusive proof that a corporation exists. The filing of the articles of incorporation is conclusive proof that a corporation exists. After that, only the state can challenge the status of the corporation. After that, only the state can challenge the status of the corporation. Third parties cannot thereafter challenge the existence of the corporation. Third parties cannot thereafter challenge the existence of the corporation.

21. 35 - 21Copyright © 2004 by Prentice-Hall. All rights reserved. S Corporations  Corporations are separate legal entities.  They generally must pay corporate income taxes to federal and state governments.  If a corporation distributes its profits to shareholders in the form of dividends, shareholders must pay personal income tax on the dividends.  This double taxation of corporations is a disadvantage of doing business.

22. 35 - 22Copyright © 2004 by Prentice-Hall. All rights reserved. S Corporations (continued)  Some corporations and their shareholders can avoid double taxation by electing to be an S Corporation.  If a corporation elects to be taxed as an S Corporation, it pays no federal income tax at the corporate level.  The corporation’s income or loss flows to the shareholders’ individual income tax returns.  Election is made by filing IRS Form 2553.

23. 35 - 23Copyright © 2004 by Prentice-Hall. All rights reserved. Financing the Corporation  A corporation needs to finance the operation of its business. Equity securities (or stocks) – represent ownership rights in the corporation. Equity securities (or stocks) – represent ownership rights in the corporation. Debt securities – establish a debtor-creditor relationship in which the corporation borrows money from the investor to whom the debt security is issued. Debt securities – establish a debtor-creditor relationship in which the corporation borrows money from the investor to whom the debt security is issued.

24. 35 - 24Copyright © 2004 by Prentice-Hall. All rights reserved. Equity Securities  Common Stock – A type of equity security that represents the residual value of the corporation. Common stock has no preferences. Common stock has no preferences. Common stock does not have a fixed maturity date. Common stock does not have a fixed maturity date. Corporations may issue different classes of common stock. Corporations may issue different classes of common stock. Common shareholders have limited liability. Common shareholders have limited liability.

25. 35 - 25Copyright © 2004 by Prentice-Hall. All rights reserved. Equity Securities (continued)  Preferred Stock – A type of equity security that is given certain preferences and rights over common stock. Preferred stock can be issued in classes or series. Preferred stock can be issued in classes or series. One class of preferred stock can be given preferences over another class of preferred stock. One class of preferred stock can be given preferences over another class of preferred stock. Preferred shareholders have limited liability. Preferred shareholders have limited liability.

26. 35 - 26Copyright © 2004 by Prentice-Hall. All rights reserved. Preferences of Preferred Stock Dividend Preference Liquidation Preference Cumulative Dividend Right Right to Participate in Profits Conversion Right

27. 35 - 27Copyright © 2004 by Prentice-Hall. All rights reserved. Types of Shares Type of Share DescriptionAuthorized Shares authorized in the corporation’s articles of incorporation. Issued Shares sold by the corporation. Treasury Shares repurchased by the corporation. They do not have the right to vote. Outstanding Shares of stock that are in shareholder hands. These shares have the right to vote.

28. 35 - 28Copyright © 2004 by Prentice-Hall. All rights reserved. Debt Securities  Debenture – A long-term unsecured debt instrument that is based on the corporation’s general credit standing.  Bond – A long-term debt security that is secured by some form of collateral.  Note – A debt security with a maturity of five years or less.

29. 35 - 29Copyright © 2004 by Prentice-Hall. All rights reserved. Express Powers of a Corporation  A corporation has the same basic rights to perform acts and enter into contracts as a physical person.  A corporation’s express powers are found in: (1) the U.S. Constitution, (2) state constitutions, (3) federal statutes, (4) state statutes, (5) articles of incorporation, (6) bylaws, and (7) resolutions of the board of directors.

30. 35 - 30Copyright © 2004 by Prentice-Hall. All rights reserved. Express Powers of a Corporation (continued)  Generally, a corporation has the power to: Purchase, own, lease, sell, mortgage, or otherwise deal in real and personal property Purchase, own, lease, sell, mortgage, or otherwise deal in real and personal property Make contracts Make contracts Lend and borrow money Lend and borrow money Incur liabilities Incur liabilities Issue notes, bonds, and other obligations Issue notes, bonds, and other obligations Invest and reinvest funds Invest and reinvest funds Sue and be sued in its corporate name Sue and be sued in its corporate name

31. 35 - 31Copyright © 2004 by Prentice-Hall. All rights reserved. Implied Powers of a Corporation  Powers beyond express powers that allow a corporation to accomplish its corporate purpose. e.g., a corporation has the implied power to open a bank account e.g., a corporation has the implied power to open a bank account e.g., a corporation has the implied power to to reimburse its employees for expenses e.g., a corporation has the implied power to to reimburse its employees for expenses

32. 35 - 32Copyright © 2004 by Prentice-Hall. All rights reserved. Dissolution of Corporations Voluntary Dissolution Administrative Dissolution Judicial Dissolution

33. 35 - 33Copyright © 2004 by Prentice-Hall. All rights reserved. Winding-up and Liquidation  The process by which a dissolved corporation’s assets are collected, liquidated, and distributed to: Creditors Creditors Shareholders Shareholders Other claimants Other claimants

34. 35 - 34Copyright © 2004 by Prentice-Hall. All rights reserved. Termination  The ending of a corporation that occurs only after the: Winding-up of the corporation’s affairs Winding-up of the corporation’s affairs Liquidation of its assets Liquidation of its assets Distribution of the proceeds to the claimants Distribution of the proceeds to the claimants