1. © 2004 West Legal Studies in Business A Division of Thomson Learning 1 Chapter 18 Corporations

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.” 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). The shares (stock) of a corporation are owned by at least one shareholder (stockholder). A corporation is a creature of statute, an artificial “person.” 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). 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 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. 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. 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. 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. 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. Individual shareholders own corporation. Shareholders elect board of directors to manage corporation. Shareholders elect board of directors to manage corporation. Board of directors hires officers to run corporation on a daily basis. Board of directors hires officers to run corporation on a daily basis. Individual shareholders own corporation. Individual shareholders own corporation. Shareholders elect board of directors to manage corporation. Shareholders elect board of directors to manage corporation. Board of directors hires officers to run corporation on a daily basis. 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 Body of shareholders can change constantly without affecting the continued existence of the corporation. 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). 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. 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). 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 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. 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. Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level. Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends. 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. 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. Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level.

7. © 2004 West Legal Studies in Business A Division of Thomson Learning 7 § 2: Classification of Corporations Domestic corporation does business in its state of incorporation. Domestic corporation does business in its state of incorporation. Foreign corporation from X state doing business in Z state. Foreign corporation from X state doing business in Z state. Alien Corporation: formed in another country doing business in United States. Alien Corporation: formed in another country doing business in United States. Domestic corporation does business in its state of incorporation. Domestic corporation does business in its state of incorporation. Foreign corporation from X state doing business in Z state. Foreign corporation from X state doing business in Z state. Alien Corporation: formed in another country doing business in United States. Alien Corporation: formed in another country doing business in United States.

8. © 2004 West Legal Studies in Business A Division of Thomson Learning 8 Classification of Corporations Public and Private. Public and Private. Nonprofit. Nonprofit. Close Corporations. Close Corporations.  Shares held by few shareholders.  More informal management,similar to a partnership.  Restriction on transfer of shares. Public and Private. Public and Private. Nonprofit. Nonprofit. Close Corporations. Close Corporations.  Shares held by few shareholders.  More informal management,similar to a partnership.  Restriction on transfer of shares.

9. © 2004 West Legal Studies in Business A Division of Thomson Learning 9 Classification of 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: “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. 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: “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. Professional Corporations.

10. © 2004 West Legal Studies in Business A Division of Thomson Learning 10 § 3: Corporate Formation The process of incorporation generally involves two steps: 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: The process of incorporation generally involves two steps:  Preliminary and Promotional Activities; and  The Legal Process of Incorporation.

11. © 2004 West Legal Studies in Business A Division of Thomson Learning 11 Incorporation Process Promotion Name Search File Articles of Incorporation Subscribers 1st Organiza- tional Meeting State Charter

12. © 2004 West Legal Studies in Business A Division of Thomson Learning 12 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. Before corporation is formed, promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements.

13. © 2004 West Legal Studies in Business A Division of Thomson Learning 13 Promoter’s Liabilities A Promoter (or corporation) can create a prospectus required by federal and state securities laws to inform and protect investors. 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. 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. 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. Promoter is personally liable for pre- incorporation contracts on behalf of the corporation, unless 3 rd party agrees to hold future corporation liable.

14. © 2004 West Legal Studies in Business A Division of Thomson Learning 14 Promoter’s Liabilities After corporate formation, corporation can adopt the pre-incorporation contract and release the promoter by creating a “novation”. 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. 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”. 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. Subscribers and Subscription Agreements: continuing contracts to purchase stock. Generally, subscribers become stockholders upon corporate formation.

15. © 2004 West Legal Studies in Business A Division of Thomson Learning 15 Articles of Incorporation State Chartering: 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.shtml http://www.sos.state.tx.us/corp/forms.shtml State Chartering: 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.shtml http://www.sos.state.tx.us/corp/forms.shtml

16. © 2004 West Legal Studies in Business A Division of Thomson Learning 16 Articles of Incorporation Choose and reserve a Corporate Name. Name must have the proper suffix: “Corporation,” “Corp.,” “Incorporated.” 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. You should also consider registering the corporation as a “dot com” at networksolutions.com or register.com. networksolutions.comregister.com networksolutions.comregister.com Choose and reserve a Corporate Name. Name must have the proper suffix: “Corporation,” “Corp.,” “Incorporated.” 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. You should also consider registering the corporation as a “dot com” at networksolutions.com or register.com. networksolutions.comregister.com networksolutions.comregister.com

17. © 2004 West Legal Studies in Business A Division of Thomson Learning 17 Articles of Incorporation Purpose: trend towards “any legal business.” Purpose: trend towards “any legal business.” Duration: usually perpetual. Duration: usually perpetual. Capital Structure: Most states requires some minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation. Capital Structure: Most states requires 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.” Purpose: trend towards “any legal business.” Duration: usually perpetual. Duration: usually perpetual. Capital Structure: Most states requires some minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation. Capital Structure: Most states requires some minimal capitalization (Texas requires $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation.

18. © 2004 West Legal Studies in Business A Division of Thomson Learning 18 Articles of Incorporation Internal Organization: usually included in the bylaws. 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. 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. Incorporators (usually the promoter): at least one with name and address. Internal Organization: usually included in the bylaws. 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. 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. Incorporators (usually the promoter): at least one with name and address.

19. © 2004 West Legal Studies in Business A Division of Thomson Learning 19 § 4: 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. 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. Problematic for shareholders who may be personally liable. In addition, entity may not be able to enforce contracts. 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. 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. Problematic for shareholders who may be personally liable. In addition, entity may not be able to enforce contracts. In addition, entity may not be able to enforce contracts.

20. © 2004 West Legal Studies in Business A Division of Thomson Learning 20 Improper Incorporation De Jure: substantial statutory requirements are met; cannot be attacked by state or 3 rd parties. 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. 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. 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 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. 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. By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists.

21. © 2004 West Legal Studies in Business A Division of Thomson Learning 21 § 5: 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. “ 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. 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. “ 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. Court concludes that shareholders used corporation as a “shield” from illegal activity.

22. © 2004 West Legal Studies in Business A Division of Thomson Learning 22 Piercing the Corporate Veil Factors a court considers: 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: 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.

23. © 2004 West Legal Studies in Business A Division of Thomson Learning 23 Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. Case 18.1: Dimmitt & Owens Financial, Inc. v. Superior Sports Products, Inc. (2002). Case 18.1: 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. Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity. Case 18.1: Dimmitt & Owens Financial, Inc. v. Superior Sports Products, Inc. (2002). Case 18.1: Dimmitt & Owens Financial, Inc. v. Superior Sports Products, Inc. (2002). Commingling of Personal and Corporate Assets

24. © 2004 West Legal Studies in Business A Division of Thomson Learning 24 § 6: Directors, Officers and Shareholders Every corporation is governed by a board of directors that are elected by the shareholders. Every corporation is governed by a board of directors that are elected by the shareholders. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. 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. A director can also be a shareholder, especially in closely-held corporations. Every corporation is governed by a board of directors that are elected by the shareholders. Every corporation is governed by a board of directors that are elected by the shareholders. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. 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. A director can also be a shareholder, especially in closely-held corporations.

25. © 2004 West Legal Studies in Business A Division of Thomson Learning 25 Role of Directors Subject to statutory limitations, the number of directors is set forth in the articles of incorporation: Subject to statutory limitations, 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.  Director can be removed for cause (for failing to perform a required duty). Subject to statutory limitations, the number of directors is set forth in the articles of incorporation: Subject to statutory limitations, 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.  Director can be removed for cause (for failing to perform a required duty).

26. © 2004 West Legal Studies in Business A Division of Thomson Learning 26 Directors’ Meetings Directors hold meetings pursuant to bylaws with recorded minutes. Directors hold meetings pursuant to bylaws with recorded minutes. Special meetings may be called with sufficient notice. Special meetings may be called with sufficient notice. Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority). Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority). Each director generally has one vote. Each director generally has one vote. Directors hold meetings pursuant to bylaws with recorded minutes. Directors hold meetings pursuant to bylaws with recorded minutes. Special meetings may be called with sufficient notice. Special meetings may be called with sufficient notice. Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority). Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority). Each director generally has one vote. Each director generally has one vote.

27. © 2004 West Legal Studies in Business A Division of Thomson Learning 27 Rights of Directors Directors have the right to: Directors have the right to:  Participate in corporate decisions and inspect corporate books and records.  Compensation (usually a nominal sum) and indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability. Directors have the right to: Directors have the right to:  Participate in corporate decisions and inspect corporate books and records.  Compensation (usually a nominal sum) and indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability.

28. © 2004 West Legal Studies in Business A Division of Thomson Learning 28 Directors’ Management Responsibilities Directors have general responsibility for all management decisions: Directors have general responsibility for all management decisions:  All major corporate policies  Appointment and removal of all corporate officers and their compensation.  Financial decisions, including dividends and retained earnings. Directors have general responsibility for all management decisions: Directors have general responsibility for all management decisions:  All major corporate policies  Appointment and removal of all corporate officers and their compensation.  Financial decisions, including dividends and retained earnings.

29. © 2004 West Legal Studies in Business A Division of Thomson Learning 29 Role of Corporate Officers and Executives Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well. Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well. Their employment relationships are generally governed by contract law and employment law. Their employment relationships are generally governed by contract law and employment law. Officers may be terminated for cause. Officers may be terminated for cause. Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well. Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well. Their employment relationships are generally governed by contract law and employment law. Their employment relationships are generally governed by contract law and employment law. Officers may be terminated for cause. Officers may be terminated for cause.

30. © 2004 West Legal Studies in Business A Division of Thomson Learning 30 Role of Corporate Officers and Executives Officers and executives are hired by the board of directors. Officers and executives are hired by the board of directors. Act as agents for the corporation. Act as agents for the corporation. Most states same person can be both officer and director. Most states same person can be both officer and director. Officers are employees of the corporation and have fiduciary and loyalty duties. Officers are employees of the corporation and have fiduciary and loyalty duties. Officers and executives are hired by the board of directors. Officers and executives are hired by the board of directors. Act as agents for the corporation. Act as agents for the corporation. Most states same person can be both officer and director. Most states same person can be both officer and director. Officers are employees of the corporation and have fiduciary and loyalty duties. Officers are employees of the corporation and have fiduciary and loyalty duties.

31. © 2004 West Legal Studies in Business A Division of Thomson Learning 31 Fiduciary Duties of Directors and Officers Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable. Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable. Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable. Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable.

32. © 2004 West Legal Studies in Business A Division of Thomson Learning 32 Fiduciary Duties of Directors and Officers Duty of Care (cont’d): Duty of Care (cont’d):  Make informed and reasonable decisions;  Rely on competent consultants and experts; and  Exercise reasonable supervision. A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings. A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings. Duty of Care (cont’d): Duty of Care (cont’d):  Make informed and reasonable decisions;  Rely on competent consultants and experts; and  Exercise reasonable supervision. A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings. A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.

33. © 2004 West Legal Studies in Business A Division of Thomson Learning 33 Duty of Loyalty: subordination of personal interests to the welfare of the corporation. 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.  No transaction that is detrimental to minority shareholders Case 18.2: In Re Cumberland Farms (2002). Case 18.2: In Re Cumberland Farms (2002). Duty of Loyalty: subordination of personal interests to the welfare of the corporation. 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.  No transaction that is detrimental to minority shareholders Case 18.2: In Re Cumberland Farms (2002). Case 18.2: In Re Cumberland Farms (2002). Fiduciary Duties of Directors and Officers

34. © 2004 West Legal Studies in Business A Division of Thomson Learning 34 No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors. No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors. Fiduciary Duties of Directors and Officers

35. © 2004 West Legal Studies in Business A Division of Thomson Learning 35 Liability of Directors and Officers Directors and officers may be liable for negligent acts that breach the standard of due care: Directors and officers may be liable for negligent acts that breach the standard of due care:  Crimes and torts committed by individually and/or those committed by employees under their supervision.  Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation]. Directors and officers may be liable for negligent acts that breach the standard of due care: Directors and officers may be liable for negligent acts that breach the standard of due care:  Crimes and torts committed by individually and/or those committed by employees under their supervision.  Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation].

36. © 2004 West Legal Studies in Business A Division of Thomson Learning 36 Business Judgment Rule Immunizes a director or officer from liability from consequences of a business decision that turned sour. Immunizes a director or officer from liability from consequences of a business decision that turned sour. Court will not require directors or officers to manage “in hindsight.” Court will not require directors or officers to manage “in hindsight.” As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply. As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply. Case 18.3: FDIC v. Castetter (1999). Case 18.3: FDIC v. Castetter (1999). Immunizes a director or officer from liability from consequences of a business decision that turned sour. Immunizes a director or officer from liability from consequences of a business decision that turned sour. Court will not require directors or officers to manage “in hindsight.” Court will not require directors or officers to manage “in hindsight.” As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply. As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply. Case 18.3: FDIC v. Castetter (1999). Case 18.3: FDIC v. Castetter (1999).

37. © 2004 West Legal Studies in Business A Division of Thomson Learning 37 Role of Shareholders Ownership of shares grants an equitable ownership interest in a corporation. Ownership of shares grants an equitable ownership interest in a corporation. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders are generally protected from personally liability by the corporate veil of limited liability. Shareholders are generally protected from personally liability by the corporate veil of limited liability. Ownership of shares grants an equitable ownership interest in a corporation. Ownership of shares grants an equitable ownership interest in a corporation. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders are generally protected from personally liability by the corporate veil of limited liability. Shareholders are generally protected from personally liability by the corporate veil of limited liability.

38. © 2004 West Legal Studies in Business A Division of Thomson Learning 38 Shareholder Powers Shareholder powers include approving all fundamental changes to the corporation: Shareholder powers include 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. Shareholders also elect and remove the board of directors. Shareholder powers include approving all fundamental changes to the corporation: Shareholder powers include 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. Shareholders also elect and remove the board of directors.

39. © 2004 West Legal Studies in Business A Division of Thomson Learning 39 Shareholder Meetings Shareholders’ meetings must occur at least annually. Voting requirements and procedures are: Shareholders’ meetings must occur at least annually. Voting requirements and procedures are:  Quorum of shareholders owning more than 50% of shares must be present to conduct business;  Shareholders may appoint a proxy or enter into a voting trust agreement. Shareholders’ meetings must occur at least annually. Voting requirements and procedures are: Shareholders’ meetings must occur at least annually. Voting requirements and procedures are:  Quorum of shareholders owning more than 50% of shares must be present to conduct business;  Shareholders may appoint a proxy or enter into a voting trust agreement.

40. © 2004 West Legal Studies in Business A Division of Thomson Learning 40 Shareholder Meetings For special shareholder meetings: For special shareholder meetings:  Notice and time of meetings must be sent in writing to each shareholder within a reasonable time ahead of the meeting.  Notice must state reason for meeting and only deal with this matter. For special shareholder meetings: For special shareholder meetings:  Notice and time of meetings must be sent in writing to each shareholder within a reasonable time ahead of the meeting.  Notice must state reason for meeting and only deal with this matter.

41. © 2004 West Legal Studies in Business A Division of Thomson Learning 41 Shareholder Voting Common shareholder entitled to one vote per share. Common shareholder entitled to one vote per share. Articles and by-laws can exclude or limit voting rights of certain classes of stock. Articles and by-laws can exclude or limit voting rights of certain classes of stock. Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present. Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present. Common shareholder entitled to one vote per share. Common shareholder entitled to one vote per share. Articles and by-laws can exclude or limit voting rights of certain classes of stock. Articles and by-laws can exclude or limit voting rights of certain classes of stock. Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present. Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present.

42. © 2004 West Legal Studies in Business A Division of Thomson Learning 42 Shareholder Voting Shareholders may vote on resolutions. Shareholders may vote on resolutions.  Need majority present for most resolutions.  Need a “super majority” (e.g., 67%) for important matters: sale of assets, etc.. Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)] Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)] Shareholders may vote on resolutions. Shareholders may vote on resolutions.  Need majority present for most resolutions.  Need a “super majority” (e.g., 67%) for important matters: sale of assets, etc.. Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)] Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)]

43. © 2004 West Legal Studies in Business A Division of Thomson Learning 43 Shareholder Voting Methods of Increasing Minority Shareholder Power Within the Corporation: Methods of Increasing Minority Shareholder Power Within the Corporation:  Cumulative Voting allows minority shareholders to get a board member elected. »x # to be elected x shareholders # of shares = shareholder can cast them all for one board nominee.  Shareholder Voting Agreements.  Voting Trusts—Trustee votes the shares. Methods of Increasing Minority Shareholder Power Within the Corporation: Methods of Increasing Minority Shareholder Power Within the Corporation:  Cumulative Voting allows minority shareholders to get a board member elected. »x # to be elected x shareholders # of shares = shareholder can cast them all for one board nominee.  Shareholder Voting Agreements.  Voting Trusts—Trustee votes the shares.

44. © 2004 West Legal Studies in Business A Division of Thomson Learning 44 Shareholder Voting Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a- 8: Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a- 8:  Proxy solicitation must include proposals which will be discussed at the meeting.  Shareholders who own $1,000 worth of stock may submit their own proxy solicitations.  Company does not have to include shareholder proposals which relate to “ordinary business operations.” Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a- 8: Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a- 8:  Proxy solicitation must include proposals which will be discussed at the meeting.  Shareholders who own $1,000 worth of stock may submit their own proxy solicitations.  Company does not have to include shareholder proposals which relate to “ordinary business operations.”

45. © 2004 West Legal Studies in Business A Division of Thomson Learning 45 Rights of Shareholders Shareholders have the right: Shareholders have the right:  To vote.  To have a stock certificate.  To purchase newly issued stock.  To dividends, when declared by board.  To inspect corporate records.  To transfer shares, with some exceptions.  To a proportionate share of corporate assets on dissolution.  To file suit on behalf of corporation. Shareholders have the right: Shareholders have the right:  To vote.  To have a stock certificate.  To purchase newly issued stock.  To dividends, when declared by board.  To inspect corporate records.  To transfer shares, with some exceptions.  To a proportionate share of corporate assets on dissolution.  To file suit on behalf of corporation.

46. © 2004 West Legal Studies in Business A Division of Thomson Learning 46 Stock Certificates Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports. Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports. Corporate ownership is intangible personal property. Corporate ownership is intangible personal property. Some states allow uncertificated stock -- no tangible certificate. Some states allow uncertificated stock -- no tangible certificate. Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports. Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports. Corporate ownership is intangible personal property. Corporate ownership is intangible personal property. Some states allow uncertificated stock -- no tangible certificate. Some states allow uncertificated stock -- no tangible certificate.

47. © 2004 West Legal Studies in Business A Division of Thomson Learning 47 Preemptive Rights Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time. Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time. Provided for in the articles of incorporation. Provided for in the articles of incorporation. Significant in a close corporation to prevent dilution and loss of control. Significant in a close corporation to prevent dilution and loss of control. Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time. Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time. Provided for in the articles of incorporation. Provided for in the articles of incorporation. Significant in a close corporation to prevent dilution and loss of control. Significant in a close corporation to prevent dilution and loss of control.

48. © 2004 West Legal Studies in Business A Division of Thomson Learning 48 Stock Warrants Transferable options to purchase newly-issued stock at a stated price. Transferable options to purchase newly-issued stock at a stated price. Warrants are publicly traded. Warrants are publicly traded. Called “rights” when option is for a short period of time. Called “rights” when option is for a short period of time. Transferable options to purchase newly-issued stock at a stated price. Transferable options to purchase newly-issued stock at a stated price. Warrants are publicly traded. Warrants are publicly traded. Called “rights” when option is for a short period of time. Called “rights” when option is for a short period of time.

49. © 2004 West Legal Studies in Business A Division of Thomson Learning 49 DividendsDividends Distribution of corporate profits or income. Distribution of corporate profits or income. Only as ordered by the Board. Only as ordered by the Board. Can be stock, cash, property, stock of other corporations. Can be stock, cash, property, stock of other corporations. State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus. State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus. Distribution of corporate profits or income. Distribution of corporate profits or income. Only as ordered by the Board. Only as ordered by the Board. Can be stock, cash, property, stock of other corporations. Can be stock, cash, property, stock of other corporations. State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus. State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus.

50. © 2004 West Legal Studies in Business A Division of Thomson Learning 50 Illegal Dividends If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received. If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received. Directors can be held personally liable for the amount of payment. Directors can be held personally liable for the amount of payment. Dividends paid when corporation is insolvent are automatically illegal. Dividends paid when corporation is insolvent are automatically illegal. If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received. If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received. Directors can be held personally liable for the amount of payment. Directors can be held personally liable for the amount of payment. Dividends paid when corporation is insolvent are automatically illegal. Dividends paid when corporation is insolvent are automatically illegal.

51. © 2004 West Legal Studies in Business A Division of Thomson Learning 51 Directors’ Failure to Declare Dividends When directors fail to declare a dividend, shareholders can sue. When directors fail to declare a dividend, shareholders can sue. Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Often, profits are retained for expansion, research or upgrades. Often, profits are retained for expansion, research or upgrades. When directors fail to declare a dividend, shareholders can sue. When directors fail to declare a dividend, shareholders can sue. Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Often, profits are retained for expansion, research or upgrades. Often, profits are retained for expansion, research or upgrades.

52. © 2004 West Legal Studies in Business A Division of Thomson Learning 52 Inspection Rights Shareholders can inspect books for a proper purpose. Shareholders can inspect books for a proper purpose.  But corporation can protect trade secrets, other confidential information.  Shareholder must have held a minimum number of shares for a minimum amount of time. All shareholders can see list of other shareholders of record. All shareholders can see list of other shareholders of record. Shareholders can inspect books for a proper purpose. Shareholders can inspect books for a proper purpose.  But corporation can protect trade secrets, other confidential information.  Shareholder must have held a minimum number of shares for a minimum amount of time. All shareholders can see list of other shareholders of record. All shareholders can see list of other shareholders of record.

53. © 2004 West Legal Studies in Business A Division of Thomson Learning 53 Transfer of Shares Shares are freely transferable unless restricted by articles and noted on the stock certificate. Shares are freely transferable unless restricted by articles and noted on the stock certificate. Closely held corporations may have “right of first refusal” or preemptive rights. Closely held corporations may have “right of first refusal” or preemptive rights. Transfer accomplished by delivery or endorsement to corporate secretary. Transfer accomplished by delivery or endorsement to corporate secretary. New shareholder must be recorded on corporate books. New shareholder must be recorded on corporate books. Shares are freely transferable unless restricted by articles and noted on the stock certificate. Shares are freely transferable unless restricted by articles and noted on the stock certificate. Closely held corporations may have “right of first refusal” or preemptive rights. Closely held corporations may have “right of first refusal” or preemptive rights. Transfer accomplished by delivery or endorsement to corporate secretary. Transfer accomplished by delivery or endorsement to corporate secretary. New shareholder must be recorded on corporate books. New shareholder must be recorded on corporate books.

54. © 2004 West Legal Studies in Business A Division of Thomson Learning 54 Rights on Dissolution Shareholders have right to pro-rata share of assets upon liquidation. Shareholders have right to pro-rata share of assets upon liquidation. Shareholder may petition the court for dissolution of the corporation for following reasons: Shareholder may petition the court for dissolution of the corporation for following reasons:  Board mishandling corporate assets.  Board deadlocked and irreparable injury will result.  Acts of directors are illegal, oppressive, or fraudulent.  Shareholders are deadlocked for two meetings and can’t elect directors. Shareholders have right to pro-rata share of assets upon liquidation. Shareholders have right to pro-rata share of assets upon liquidation. Shareholder may petition the court for dissolution of the corporation for following reasons: Shareholder may petition the court for dissolution of the corporation for following reasons:  Board mishandling corporate assets.  Board deadlocked and irreparable injury will result.  Acts of directors are illegal, oppressive, or fraudulent.  Shareholders are deadlocked for two meetings and can’t elect directors.

55. © 2004 West Legal Studies in Business A Division of Thomson Learning 55 Shareholder Derivative Suit Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Directors may refuse to take action because they might personally be liable. Directors may refuse to take action because they might personally be liable. Any damages recovered go to corporation’s treasury. Any damages recovered go to corporation’s treasury. Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Directors may refuse to take action because they might personally be liable. Directors may refuse to take action because they might personally be liable. Any damages recovered go to corporation’s treasury. Any damages recovered go to corporation’s treasury.

56. © 2004 West Legal Studies in Business A Division of Thomson Learning 56 Liability of Shareholders Shareholders are generally not liable for the contracts or torts of the corporation. Shareholders are generally not liable for the contracts or torts of the corporation. If the corporation fails, shareholders cannot lose more than their investment, except when: If the corporation fails, shareholders cannot lose more than their investment, except when:  A shareholder hasn’t paid for stock pursuant to the subscription agreement.  Shareholder buys “watered stock” which is below the stock’s par value. Shareholders are generally not liable for the contracts or torts of the corporation. Shareholders are generally not liable for the contracts or torts of the corporation. If the corporation fails, shareholders cannot lose more than their investment, except when: If the corporation fails, shareholders cannot lose more than their investment, except when:  A shareholder hasn’t paid for stock pursuant to the subscription agreement.  Shareholder buys “watered stock” which is below the stock’s par value.

57. © 2004 West Legal Studies in Business A Division of Thomson Learning 57 Liability of Shareholders Stock subscriptions are written irrevocable contracts to purchase capital stock of a corporation prior to incorporation. Failure to sell or buy shares is a breach of contract. Stock subscriptions are written irrevocable contracts to purchase capital stock of a corporation prior to incorporation. Failure to sell or buy shares is a breach of contract. Par-value shares: corporation must have a value equal to the total value of the shares. Par-value shares: corporation must have a value equal to the total value of the shares. Watered stock: worth less than FMV of stock. Shareholder is personally liable for difference. Watered stock: worth less than FMV of stock. Shareholder is personally liable for difference. Stock subscriptions are written irrevocable contracts to purchase capital stock of a corporation prior to incorporation. Failure to sell or buy shares is a breach of contract. Stock subscriptions are written irrevocable contracts to purchase capital stock of a corporation prior to incorporation. Failure to sell or buy shares is a breach of contract. Par-value shares: corporation must have a value equal to the total value of the shares. Par-value shares: corporation must have a value equal to the total value of the shares. Watered stock: worth less than FMV of stock. Shareholder is personally liable for difference. Watered stock: worth less than FMV of stock. Shareholder is personally liable for difference.

58. © 2004 West Legal Studies in Business A Division of Thomson Learning 58 Duties of Majority Shareholders Majority shareholders own enough shares to exercise de facto (actual) control over the corporation. Majority shareholders own enough shares to exercise de facto (actual) control over the corporation. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control. Case 18.4: Hayes v. Olmsted & Assoc. (2001). Case 18.4: Hayes v. Olmsted & Assoc. (2001). Majority shareholders own enough shares to exercise de facto (actual) control over the corporation. Majority shareholders own enough shares to exercise de facto (actual) control over the corporation. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control. Case 18.4: Hayes v. Olmsted & Assoc. (2001). Case 18.4: Hayes v. Olmsted & Assoc. (2001).

59. © 2004 West Legal Studies in Business A Division of Thomson Learning 59 Law on the Web SEC Edgar database. SEC Edgar database. SEC Edgar database. SEC Edgar database. State Corporation Statutes at Cornell U. State Corporation Statutes at Cornell U. State Corporation Statutes State Corporation Statutes The Texas Business Corporation Act. The Texas Business Corporation Act. 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. 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 FAQ’s on incorporation at Bizfilings.com FAQ’s on incorporation at Bizfilings.com FAQ’s on incorporation at Bizfilings.com Legal Research Exercises on the Web. Legal Research Exercises on the Web. Legal Research Exercises on the Web. Legal Research Exercises on the Web. SEC Edgar database. SEC Edgar database. SEC Edgar database. SEC Edgar database. State Corporation Statutes at Cornell U. State Corporation Statutes at Cornell U. State Corporation Statutes State Corporation Statutes The Texas Business Corporation Act. The Texas Business Corporation Act. 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. 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 FAQ’s on incorporation at Bizfilings.com FAQ’s on incorporation at Bizfilings.com FAQ’s on incorporation at Bizfilings.com Legal Research Exercises on the Web. Legal Research Exercises on the Web. Legal Research Exercises on the Web. Legal Research Exercises on the Web.