Chapter 30 Corporate Formation and Financing

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Chapter 30Corporate Formation and Financing
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Learning Objectives

• What are the express and implied powers of
  corporations?
• What steps are involved in bringing a corporation
  into existence?
• What is the difference between a de jure and de
  facto corporation?
• When might a court disregard the corporate entity
  and hold shareholders personally liable?
• How are corporations financed?

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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 Corporate 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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Ultra Vires Doctrine

• Corporate acts are beyond the express or implied
  powers of the corporation as stated in state
  statute or the corporations own articles of
  incorporations and are considered to be ultra
  vires (beyond the powers).
• Corporate articles of incorporations now adopt
  very broad purposes to prevent lawsuits against
  the corporation.

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Ultra Vires Doctrine 2

• The Following remedies are available for ultra
  vires acts
• Shareholders can bring action for corporation.
• Corporation can recover damages from its officers
  and directors.
• Attorney general of state may bring action to
  dissolve corporation for ultra vires acts.

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

• Before corporation is formed, 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

• 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.
• See sample incorporation rules at the Texas
  Secretary of State.

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Incorporation Procedures

• Choose and reserve a Corporate Name (Example
  name search at Texas Secretary of State). 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 Status

• Errors in incorporation procedures when a 3rd
  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.
• In addition, entity may not be able to enforce
  contracts.

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Corporate Status

• De Jure substantial statutory requirements are
  met cannot be attacked by state or 3rd parties.
  
• De Facto statutory requirements not met, but
  promoters made good faith effort to comply with
  corporate lawcorporate status can only be
  attacked by state.
• By Estoppel if it acts like a corporation,
  cannot avoid liability by claiming that no
  corporation exists.

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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.
• Court concludes that shareholders used
  corporation as a shield from illegal activity.

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Disregarding the Corporate Entity

• Factors a court considers
• 3rd 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.
• Corporation is alter ego of majority
  shareholder and personal and corporate interest
  are commingled such that the corporation has no
  separate identity.

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Corporate Financing
Bonds vs. Stocks
Debt Ownership/equity
Fixed ROI Dividends (variable)
No votes Vote for Management
Optional Required
Priority over stock Paid last
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Bonds
Type Definition
Debentures No specific corporate assets are pledged as collateral. Backed by corporations general credit rating.
Mortgages Pledge specific real estate. If corporation defaults, bondholders can foreclose.
Convertible Conditions trigger bonds to convert to corporate stock.
Callable Can be called in by principal and repaid according to bond conditions.
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Stocks

• Common Stock represents true ownership of a
  corporation. Provides pro-rata (proportional)
  ownership interest reflected in control, earnings
  and assets.
• Preferred Stock has preferences over common
  stock.
• Cumulative Preferred.
• Participating Preferred.
• Convertible Preferred.
• Redeemable or Callable Preferred.