1. © 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. Chapter 15: CorporationsChapter 15: Corporations © 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.

2.  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 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.  Corporations are recognized as legal “persons” and enjoy virtually same rights and privileges under our Constitution as natural persons. Corporate Nature and Classification 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.  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 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.  Corporate Personnel. Shareholders can sue corporation and be sued by corporation and bring suit for corporation in some instances. 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.  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 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 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 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.  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 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.  Torts and Criminal Acts. Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison. 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.  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 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.  Classification of Corporations. Public and Private Corporations. Nonprofit Corporations.  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. Closely Held Corporations. Management of Closely Held Corporations. Transfer of Shares Shareholder Agreement to Restrict Stock. Misappropriation of Closely Held Corporation Funds. CASE 15.1 R UBIN V. M URRAY (2011). CASE 15.1 R UBIN V. M URRAY (2011). How would you determine reasonable compensation? 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. “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 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. “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 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. Corporate Formation and Powers  The process of incorporation generally involves two steps: Preliminary and Promotional Activities; and  The Legal Process of Incorporation.  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. 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.  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. 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. 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  Incorporation Procedures. Promotion Name Search File Articles of Incorporation Subscribers 1st Organiza- tional Meeting State Charter 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  Incorporation Procedures. Select State of Incorporation. Secure the Corporate Name. Must include words that disclose corporate status. Cannot infringe on another’s trademark name.  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  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. 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  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. 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  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. 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  Improper Incorporation. Corporation by Estoppel: If it acts like a corporation, it cannot avoid liability by claiming that no corporation exists. 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  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. 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  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. 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. 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. 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.  In certain situations, courts will “pierce the corporate veil” and hold shareholders personally liable in the interests of justice and fairness.  Piercing the Corporate Veil 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.  Factors That Lead Courts to Pierce. 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.  Piercing the Corporate Veil 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.  Factors That Lead Courts to Pierce. Corporation is formed to evade an existing legal obligation. Statutory formalities are not followed. Commingling of personal and corporate interests or assets. Piercing the Corporate Veil 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.  A Potential Problem for Closely Held Corporations. CASE 15.2 S CHULTZ V. G ENERAL E LECTRIC H EALTHCARE F INANCIAL S ERVICES (2010). CASE 15.2 S CHULTZ V. G ENERAL E LECTRIC H EALTHCARE F INANCIAL S ERVICES (2010). Why was Schultz personally liable? Piercing the Corporate Veil 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.  Directors: Individual directors are not agents of corporation. Only the board itself can act as a “super-agent” and bind the corporation. A director can also be a shareholder, especially in closely-held corporations. Directors and Officers 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.  Directors. Election of Directors. Generally, the number of directors is set forth in the articles of incorporation: Directors appointed at the first organizational meeting. In closely held companies, directors are generally the incorporators and/or the shareholders. Term of office is generally for one year.  Directors and Officers 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.  Directors. Election of Directors. Removal of Directors: directors can be removed for cause. Vacancies on Board: if director dies or resigns or new position created by the articles or bylaws. Directors and Officers 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.  Directors. Compensation of Directors. Inside director (officer), vs. outside director. Often the same person is both an officer and director, and receives compensation as an officer. Board of Directors’ Meetings. Quorum must be present to conduct official business.  Directors and Officers 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.  Directors. Committees of the Board. Executive Committee. Audit Committee. Nominating Committee. Compensation Committee. Litigation Committee. Directors and Officers 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.  Directors. Rights of Directors. Participate in corporate decisions and inspect corporate books and records. Compensation (usually a nominal sum). Corporation should guarantee reimbursement or purchase liability insurance to protect the board from personal liability. Directors and Officers 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 Officers and Executives. Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company. Their employment relationships are generally governed by contract law and employment law. Officers may be terminated for cause. Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Directors and officers are fiduciaries and owe the company ethical and legal duties. Duty of Care. Duty to Make Informed Decisions. Directors are expected to be fully informed on corporate matters.  Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Duty of Care (cont’d). Duty to Exercise Reasonable Supervision. Directors are expected to supervise officers when delegated work. Dissenting Directors: rarely held individually liable to the corporation. Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Business Judgment Rule: immunizes a director or officer from liability from bad decisions. Court will not require directors or officers to manage “in hindsight.” BJR will apply as long as decision was reasonable, informed, made in good faith and best interests of the corp. Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Duty of Loyalty : subordination of personal interests to the welfare of the corporation. No competition with Corporation. No “corporate opportunity.” No conflict of interests. No insider trading.  Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Duty of Loyalty. No transaction that is detrimental to minority shareholders.. CASE 15.3 G UTH V. L OFT, I NC. (1939). CASE 15.3 G UTH V. L OFT, I NC. (1939). What were the two parts of the duty test the court used to determine whether the corporate executives had violated their duty of loyalty? Directors and Officers 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.  Duties and Liabilities of Directors and Officers. Disclosure of Potential Conflicts of Interest. Directors and officers must provide full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. If reasonable, can be approved. Directors and Officers 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.Shareholders  Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors.  Controlling shareholders owe a fiduciary duty to minority shareholders. 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.Shareholders  Shareholder Powers. Approving all fundamental changes to the corporation. Amending articles of incorporation or bylaws. Approval of mergers or acquisition. Sale of all corporate assets or dissolution. Shareholders also elect and remove the board of directors. 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.Shareholders  Shareholders’ Meetings. Must occur at least annually. Voting requirements and procedures are: Notice of Meetings. Proxies. Shareholder Proposals. 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.Shareholders  Shareholders’ Meetings. Shareholder Voting. Quorum Requirements: shareholders representing more than 50% of shares must be present to conduct business. Voting Lists: record of stock ownership.  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.Shareholders  Shareholders’ Meetings. Shareholder Voting. Cumulative Voting: allows minority shareholders to get a board member elected. Other Voting Techniques. – Shareholder Voting Agreements. – Voting Trusts—Trustee votes the shares. 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.Shareholders  Rights of Shareholders. Shareholder Voting: shareholders may have various rights, depending on the articles and bylaws: Stock Certificates. Preemptive Rights: allows each shareholder to maintain his proportional control. Stock Warrants: buy at a stated price. 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.Shareholders  Rights of Shareholders. Dividends: distribution of corporate profits or income ordered by the board. Illegal Dividends. Directors’ Failure to Declare a Dividend. Inspection Rights. Transfer of Shares.  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.Shareholders  Rights of Shareholders. Rights on Dissolution. Shareholder’s Derivative Suit. Shareholders sue a third party on behalf of the corporation, if the Directors fail or refuse to correct the wrong or injury. Shareholders must first ‘make demand’ on the board which then has 90 days to decide.  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.Shareholders  Rights of Shareholders. Shareholder’s Derivative Suit. When shareholders bring a derivative suit, they are doing so in the name of the company, not individually. 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.Shareholders  Duties and Liabilities of Shareholders. Shareholders are generally not liable for the contracts or torts of the corporation. If the corporation fails, shareholders generally cannot lose more than their investment.  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.Shareholders  Duties and Liabilities of Shareholders. Watered Stock: worth less than fair market value. Shareholder is personally liable for difference. Breach of Fiduciary Duty: can occur when a shareholder has enough shares to control the corporation. 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. Major Business Forms Compared 55

56. © 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. Major Business Forms Compared 56