1. Chapter 1: Legal Ethics 1

2. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives 1.What steps are involved in bringing a corporation into existence? 2.In what circumstances might a court disregard the corporate entity (pierce the corporate veil) and hold the shareholders personally liable? 3.How are corporations financed?  2

3. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives 1.What are the steps of a merger, a consolidation, or a share exchange process? 2.What are the two ways in which a corporation can be voluntarily dissolved? 3

4. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  A corporation is a creature of statute, an artificial “person.” – Corporations can have one or more shareholders. – Owners can be natural persons or other businesses. – Corporation substitutes itself for shareholders. Corporate Nature and Classification 4

5. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Corporations are recognized as legal “persons” and enjoy virtually same rights and privileges under our Constitution as natural persons. Corporate Nature and Classification 5

6. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Corporate Personnel. – Responsibility for overall management of company rests with board of directors (elected by shareholders). – Board of directors makes policy decisions and hires officers to run corporation on a daily basis.  Corporate Nature and Classification 6

7. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Corporate Personnel. – Shareholders can sue corporation and be sued by corporation and bring suit for corporation in some instances.  Constitutional Rights of Corporations. – Recognized as a legal “person” with protections under the Bill of Rights, federal, and state statutes. Corporate Nature and Classification 7

8. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Limited Liability of Shareholders. – One of the key advantages of corporations is the limited liability of shareholders – In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable. Corporate Nature and Classification 8

9. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Corporate Earnings and Taxation. – Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. – Corporate Taxation: corporate taxes can be taxes twice, first to the corporation, then to the shareholders via dividends.  Corporate Nature and Classification 9

10. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Torts and Criminal Acts. – 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.  Corporate Nature and Classification 10

11. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Torts and Criminal Acts. – Corporation can be liable for criminal acts, but only fined. – Responsible officers may go to prison. Corporate Nature and Classification 11

12. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  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. Corporate Nature and Classification 12

13. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Classification of Corporations. – Public and Private Corporations. – Nonprofit Corporations.  Corporate Nature and Classification 13

14. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Classification of Corporations. – Closely Held Corporations. Management of Closely Held Corporations. Transfer of Shares Shareholder Agreement to Restrict Stock.  Corporate Nature and Classification 14

15. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Classification of Corporations. – Closely Held Corporations. Misappropriation of Closely Held Corporation Funds. CASE 24.1 R UBIN V. M URRAY (2011). CASE 24.1 R UBIN V. M URRAY (2011). How would you determine reasonable compensation? Corporate Nature and Classification 15

16. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Classification of Corporations. – “S” Corporations: avoids federal tax under IRS Code “Subchapter S.” Avoids federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income.  Corporate Nature and Classification 16

17. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Classification of Corporations. – “S” Corporations: avoids federal tax under IRS Code “Subchapter S.” IRS requirements: Corporation is domestic, fewer than 100 shareholders, only one class of stock, no shareholder can be a non-resident alien. – Professional Corporations. Corporate Nature and Classification 17

18. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  The process of incorporation generally involves two steps: – Promotional Activities; and  – Incorporation Procedures.  18

19. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  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.  19

20. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Promotional Activities. – Promoter’s Liability: Promoter is personally liable for pre-incorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable. 20

21. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Incorporation Procedures. – Select State of Incorporation. – Secure the Corporate Name. Must include words that disclose corporate status. Cannot infringe on another’s trademark name.  21

22. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Incorporation Procedures. – Prepare the Articles of Incorporation: which deals with shares, the registered agent and office, incorporators, duration and purpose, and internal organization. – File the articles with the state. 22

23. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  First Organizational Meeting. – Adopt Bylaws: After the corporation is “chartered” (created) it can do business. At meeting, shareholders should approve the bylaws, elect directors, hire officers and ratify pre-incorporation contracts and activities. 23

24. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  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; can only be attacked by state.  24

25. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Improper Incorporation. – Corporation by Estoppel: If it acts like a corporation, it cannot avoid liability by claiming that no corporation exists. 25

26. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Corporate Powers. – Express Powers. 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. 26

27. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Corporate Powers. – Implied Powers. To perform all acts reasonably necessary to accomplish its corporate purposes. A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise. 27

28. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Formation and Powers  Corporate Powers. – Ultra Vires Doctrine. Corporate acts beyond the express or implied powers of the corporation (by statute of articles of incorporation). Corporate articles of incorporations now adopt very broad purposes to prevent lawsuits against the corporation. 28

29. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Piercing the Corporate Veil – In certain situations, courts will “pierce the corporate veil” and hold shareholders personally liable in the interests of justice and fairness.  Corporate Formation and Powers 29

30. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Factors That Lead Courts Use to Pierce the Veil. – A party is 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.  Corporate Formation and Powers 30

31. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Factors That Lead Courts Use to Pierce the Veil. – Corporation is formed to evade an existing legal obligation. – Statutory formalities are not followed. – Commingling of personal and corporate interests or assets.  Corporate Formation and Powers 31

32. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Piercing the Corporate Veil: A Potential Problem for Closely Held Corporations. – CASE 24.2 S CHULTZ V. G ENERAL E LECTRIC H EALTHCARE F INANCIAL S ERVICES (2010). – CASE 24.2 S CHULTZ V. G ENERAL E LECTRIC H EALTHCARE F INANCIAL S ERVICES (2010). Why was Schultz personally liable? Corporate Formation and Powers 32

33. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Financing Bonds vs. Stocks DebtOwnership/equity Fixed ROIDividends (variable) No votesVote for Management OptionalRequired Priority over stockPaid last 33

34. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Financing  Stocks: Issued by business firms and government at all levels. – Normally have a maturity date – when principal is returned to investor. – Sometimes referred to as fixed-income securities, because bondholders receive fixed-dollar interest payments. – Bond indenture: lending agreement. 34

35. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Financing  Common Stock: represents true ownership of a corporation. – Provides pro-rata (proportional) ownership interest reflected in voting, control, earnings and assets. – Investors who assume a residual financing position (whatever is left may go to dividends to shareholders).  35

36. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Financing  Preferred Stock: has preferences over common stock. – Cumulative Preferred. – Participating Preferred. – Convertible Preferred. – Redeemable or Callable Preferred. 36

37. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Corporate Financing  Venture Capital: start-up businesses and high-risk enterprises need start-up and expansion capital. The start-up typically gives a share of its stock.  Private Equity Capital: obtain capital from wealthy investors. Ultimately, the company may sell shares in an IPO. 37

38. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Merger: combination of two or more corporations (A & B), after which only one company remains (A), with all of B’s rights and obligations. Merger and Acquisitions 38

39. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Consolidation: when two or more corporations (A & B) combine and a new corporation (C) is created, with A and B ceasing to exist. Merger and Acquisitions 39

40. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merger and Acquisitions  Share Exchange: some or all the shares of one corporation are exchanged for some or all of the shares of another corporation.  Procedures. – Board of Directors of each corporation involved must approve the merger plan.  40

41. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merger and Acquisitions  Procedures (cont’d): – Majority of shareholders of each corporation must approve. – Then, documents are filed with Secretary of State who issues a certificate of merger. 41

42. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merger and Acquisitions   Short-Form Mergers. – For “Parent-Subsidiary” Merger. – No approval of shareholders needed. – Parent must own at least 90% of each class of stock of the subsidiary corporation. – Board of parent corporation approves and new articles filed. 42

43. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merger and Acquisitions  Shareholder Approval.  Merger, consolidation, sale of most of corporation’s assets not in the ordinary course of business, adverse amendments to the articles of incorporation. 43

44. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merger and Acquisitions  Appraisal Rights. Shareholder has the right to be “bought out” of his/her shares. – Procedures: corporation notifies shareholders, who can demand fair market value appraisal. – Appraisal Rights and Shareholders Status: dissenting shareholder looses voting rights. 44

45. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Assets. – The acquiring corporation extends its ownership and control over the physical assets of another company. Acquiring corporation shareholders do not need to approve. – Sale of Corporate Assets. Must have approval of directors and shareholders.  45

46. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Assets. – Successor Liability in Purchases of Assets. Generally, the purchasing corporation is not automatically responsible for the liabilities of the selling company. In the following situations, the purchasing company will be held to have assumed both the assets and liabilities of the selling company.  46

47. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Assets. – Successor Liability (cont’d). Purchasing company assumes both liabilities and assets if: Acquiring corporation impliedly or expressly assumes the liabilities. Sale amounts to what is really a merger or consolidation. Purchaser continues the seller’s business and retains the same personnel.  47

48. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Assets. – Successor Liability (cont’d). Purchasing company assumes both liabilities and assets if: Sale is fraudulently executed to escape liability. CASE 24.3 American Standard, Inc. v. OakFabco, Inc. (2010). Was the purchasing company responsible for liabilities after closing? 48

49. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Stock and Tender Offers. – Purchase of Stock: Common alternative to merger or consolidation is the purchase of a controlling interest (up to 51%) of a “target” corporation’s stock (called a “takeover”) giving the purchaser corporation controlling interest in the target.  49

50. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Stock and Tender Offers. – Tender Offers. A publicly advertised offer addressed to all shareholders of the target is called a tender offer. Tender offer is usually higher than market value per share but conditioned on the acquisition of a certain % of shares – Can be in exchange for aggressor's stock. – The SEC strictly regulates tender offers. 50

51. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Mergers and Acquisitions  Purchase of Stock and Tender Offers. – Tender Offers. Responses: Directors may view the offer as favorable or unfavorable. If favorable, then a recommendation is made to the shareholders. If unfavorable, directors may make a self- tender to buy stock, launch a media campaign, or issue additional stock. 51

52. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Termination  Voluntary Dissolution. – Shareholders can initiate dissolution or the board can initiate by submitting a proposal to the shareholders. 52

53. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Termination  Involuntary Dissolution. – State can dissolve a corporation for failure to comply with state regulations. – Court can dissolve a corporation if there is a deadlock, the acts of directors are fraudulent or illegal.  53

54. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Termination  Involuntary Dissolution (cont’d). – Court can dissolve if assets are being misapplied or wasted. – Shareholders are deadlocked and failed to resolve. 54

55. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Termination  Winding Up. – Voluntary Dissolution: Board liquidates and acts as trustees of assets. Court will appoint a receiver if board refuses; or creditors want a receiver. – Involuntary Dissolution: court appoints receiver. – Liquidated assets first to creditors, then shareholders. 55