CHAPTER 20 Corporations

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CHAPTER 20Corporations
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Learning Objectives

• What are the express and implied powers of
  corporations? On what sources are these powers
  based?
• What are the duties of corporate directors and
  officers?
• What must directors do to avoid liability for
  honest mistakes of judgment and poor business
  decisions?
• What role do corporate shareholders play in the
  corporate enterprise? What are some of the
  important rights of shareholders?
• What is the difference between a corporate merger
  and a corporate consolidation? What steps are
  involved in the termination of a corporate
  enterprise?

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The Nature of the Corporation

• A corporation is a creature of statute, an
  artificial person.
• Most states follow the Model Business Corporation
  Act (MBCA) or the RMBCA, that are model
  corporation laws.
• The shares (stock) of a corporation are owned by
  at least one shareholder (stockholder).

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Constitutional Rights of Corporations

• A corporation is an artificial person and has
  constitutional rights to
• Equal protection
• Access to the courts, can sue and be sued
• Right to due process before denial of life,
  liability or property.

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Constitutional Rights of Corporations

• Corporations rights (contd)
• Freedom from unreasonable search and seizure and
  double jeopardy.
• Freedom of speech.
• Only officers and directors have protection
  against self-incrimination.
• However, corporations do not have full protection
  of privileges and immunities clause.

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Limited Liability of Shareholders

• The corporation provides limited liability for
  stockholders.
• In certain situations, the corporate veil of
  limited liability can be pierced, holding the
  shareholders personally liable.

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Corporate Taxation

• Corporate profits can either be kept as retained
  earnings or passed on to the shareholders as
  dividends.
• Corporate profits are taxed under federal and
  state law as a separate person from its
  shareholders.
• Regular C corporations are taxed twice at the
  corporate level and at the shareholder level.

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Torts and Criminal Acts

• A corporation is liable for the torts committed
  by its agents or officers within the course and
  scope of their employment under the doctrine of
  respondeat superior.
• Corporation can be liable for criminal acts, but
  only fined. Responsible officers may go to
  prison.

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Corporate Powers

• A corporation may act and enter into contracts as
  any natural person, except as limited by
• U.S. Constitution.
• State constitutions.
• State statutes.
• Its own articles of incorporation.
• Its own corporate bylaws.
• Resolutions by its own board.

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Express Corporate Powers

• The express powers of a corporation are found in
  the corporations 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
  corporations express powers.

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Implied Powers

• Corporation has implied powers to to perform all
  acts reasonably necessary to accomplish its
  corporate purposes, e.g.,
• Borrow and lend money.
• Extend credit.
• Make charitable contributions.
• A corporate officer can bind corporation in
  contract in matters connected with the ordinary
  business affairs of the enterprise.

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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.

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Classification of Corporations

• Public and Private.
• Nonprofit.
• Close Corporations.
• Shares held by few shareholders.
• More informal management,similar to a
  partnership.
• Restriction on transfer of shares.

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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
• Corporation is domestic, fewer than 75
  shareholders, only one class of stock, no
  shareholder can be a non-resident alien.
• Professional Corporations.

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Corporate Formation

• The process of incorporation generally involves
  two steps
• Preliminary and Promotional Activities and
• The Legal Process of Incorporation.

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Promotional Activities

• Promoters are the persons who take the
  preliminary steps of organizing the venture and
  attracting subscribers (investors) via
  subscription agreements.
• A Promoter (or corporation) can create a
  prospectus required by federal and state
  securities laws to inform and protect investors.

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Promoters Liabilities

• Promoter is personally liable for
  pre-incorporation contracts on behalf of the
  corporation, unless 3rd party agrees to hold
  future corporation liable.
• After corporate formation, corporation can adopt
  the pre-incorporation contract and release the
  promoter by creating a novation.

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Incorporation Procedures
Promotion
Name Search
Subscribers
File Articles of Incorporation
1st Organiza-tional Meeting
State Charter
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Incorporation Procedures

• State Chartering Select state (some states such
  as Delaware cater to corporations).
• 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.

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Incorporation Procedures

• 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.

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Incorporation Procedures

• Purpose trend towards any legal business.
• 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.

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Incorporation Procedures

• 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 3rd parties.
• Incorporators (usually the promoter) at least
  one with name and address.

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First Organizational Meeting

• After the corporation is chartered (created) it
  and can do business.
• Shareholders should have the first organizational
  meeting to approve the bylaws, elect directors,
  hire officers and adopt pre-incorporation
  contracts and activities.

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Corporate Management-Directors and Officers

• Every corporation is governed by a board of
  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.

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Election of Directors

• 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).

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Board of Directors Meetings

• Directors hold meetings pursuant to bylaws with
  recorded minutes.
• Special meetings may be called with sufficient
  notice.
• Meetings require QUORUM (minimum number of
  directors to conduct official corporate business,
  usually majority).
• Each director generally has one vote.

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Role of Corporate Officers and Executives

• 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.
• Officers may be terminated for cause.

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Duties and Liabilities of Directors and Officers

• 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.

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Duties and Liabilities of Directors and Officers

• Duty of Care (contd)
• Make informed and reasonable decisions
• Rely on competent consultants and experts and
• Exercise reasonable supervision.

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Duties and Liabilities of Directors and Officers

• 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.

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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.
• No transaction that is detrimental to minority
  shareholders.
• In re Cumberland Farms, Inc. (2002).

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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.

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Liability of Directors and Officers

• 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.

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Business Judgment Rule

• 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.
• As long as decision was reasonable, informed,
  made in good faith and in the best interests of
  the corporation, BJR will apply.

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Corporate Ownership--Shareholders

• Ownership of shares grants a shareholder 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 are generally protected from
  personally liability by the corporate veil of
  limited liability.

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Shareholder Powers

• 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.

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Shareholder Meetings

• 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.

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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.

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Shareholder Voting

• Common shareholder entitled to one vote per
  share.
• 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.

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Shareholder Voting

• 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.

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Shareholder Voting

• Methods of Increasing Minority Share-holder 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.

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Shareholders Rights

• 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.

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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.
• Provided for in the articles of incorporation.
• Significant in a close corporation to prevent
  dilution and loss of control.

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Dividends

• Distribution of corporate profits or income.
• Only as ordered by the Board.
• 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.

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Directors Failure to Declare a Dividend

• 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).
• Often, profits are retained for expansion,
  research or upgrades.

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Liability of Shareholders

• 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
• A shareholder hasnt paid for stock pursuant to
  the subscription agreement.
• Shareholder buys watered stock which is below
  the stocks par value.

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Duties of Majority Shareholders

• 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.
• Robbins v. Sanders (2004).

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Merger and Consolidation

• Corporations can grow and expand by
• Mergers.
• Consolidation.
• Purchase of another corporations assets.
• Purchases of a controlling interest in another
  corporation.

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Merger

• Legal combination of two or more corporations (A
  B) after which only A corporation remains. As
  articles of incorporation are amended to include
  articles of merger.
• After merger, A continues as the surviving
  corporation with all of Bs rights and
  obligations.

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Consolidation

• Occurs when two or more corporations (A B)
  combine such that both cease to exist and a new
  corporation emerges which has all the rights and
  obligations previously held by A and B.
• Cs articles of consolidation take the place of
  the original articles of A and B.

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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 unless
• Acquiring corporation is paying for assets with
  its own stock and there is not enough stock
  authorized or
• Acquiring corporation sells on a national
  exchange, is paying with its own stock, and newly
  issued stock 20 or more than the outstanding
  shares.

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Purchase of Assets Liabilities

• Generally, an acquiring corporation is not liable
  for liabilities of selling corporation unless
• The acquiring corporation impliedly or expressly
  assumes the liabilities.
• Sale amounts to what is really a merger or
  consolidation.
• Purchaser continues the sellers business and
  retains the same personnel.
• Sale is fraudulently executed to escape
  liability.
• The selling corporation needs both board and
  shareholder approval.

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Purchase of Stock

• Alternative to merger or consolidation is the
  purchase of a controlling interest (e.g., 51) of
  a target corporations stock (called a
  takeover) giving the purchaser corporation
  controlling interest in the target.
• The aggressor deals entirely with the targets
  shareholders.

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Purchase of Stock Tender

• 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.
• Sec strictly regulates tender offers.

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Termination

• Termination of a corporation, like a partnership,
  consists of two phases
• Dissolution (voluntary or involuntary) and
• Liquidation.
• Dissolution can brought about by
• Act of legislature.
• Certificate expiration.
• Voluntary approval by shareholders and board.
• Unanimous action by all shareholders.
• Court order.

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Dissolution

• Shareholders can initiate dissolution by a
  unanimous vote to dissolve.
• Or, the Board can initiate by submitting a
  proposal to the shareholders for a vote at the
  annual shareholder meeting or specially-called
  meeting.
• Colt v. Mt. Princeton Trout Club, Inc. (2003).

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Liquidation

• 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.