CHAPTER 36

1. CHAPTER 36 CORPORATE FORMATION AND FINANCING © 2010 Pearson Education, Inc., publishing as Prentice-Hall

2. Corporation A fictitious legal entity that is created according to statutory requirements.

3. Nature of the Corporation Corporations created under state corporations codes. State statutes that regulate the formation, operation, and dissolution of corporations. Courts interpret state corporation statutes to decide individual corporate and shareholder disputes.

4. The Corporation as a Legal “Person” A corporation is a separate legal entity (or legal person). Corporations can: Sue or be sued in their own names. Enter into and enforce contracts. Hold title to and transfer property. Be found civilly and criminally liable for violations of law.

5. Characteristics of Corporations Limited Liability of Shareholders Free Transferability of Shares Perpetual Existence Centralized Management

6. Limited Liability of Shareholders Shareholders are only liable to the extent of their capital contributions for the contracts and debts of the corporation. Not personally liable.

7. Free Transferability of Shares Corporate shares are freely transferable by the shareholder. May sell, assign, pledge, or gift. Unless issued pursuant to certain exceptions from securities registration. Shareholders may agree among themselves to restrict transfer of shares.

8. Perpetual Existence Corporations exist in perpetuity. Unless specific duration is stated in articles of incorporation. Can be voluntarily terminated by the shareholders. May be involuntarily terminated by the corporation’s creditors if involuntary petition for bankruptcy is granted.

9. Centralized Management Board of directors makes policy decisions concerning the operation of the corporation. Members of the board elected by the shareholders. Directors appoint corporate officers to run the corporation’s day-to-day operations. Directors and the officers form the corporate management.

10. Revised Model Business Corporation Act (RMBCA) Model Business Corporation Act (MBCA) Model act drafted in 1950. Intended to provide a uniform law for regulation of corporations. Revised Model Business Corporation Act (RMBCA) 1984 revision of the MBCA. Many states have adopted all or part of the RMBCA.

11. No general federal corporations law. Many specific federal laws regulate the operation of private corporations. E.g., federal securities, labor, antitrust, consumer protection laws.

12. Public v. Private Public Corporation A corporation formed to meet a specific governmental or political purpose. E.g., many cities and towns, park districts. Private Corporation A corporation formed to conduct privately owned business. E.g., Microsoft, IBM, Starbucks, etc.

13. Profit v. Nonprofit Profit Corporation A corporation created to conduct a business for profit. Can distribute profits to shareholders in the form of dividends. Nonprofit Corporation A corporation formed to operate charitable institutions, colleges, universities, and other not-for-profit entities.

14. Publicly Held v. Closely Held Publicly Held Corporation Many shareholders. Shares traded on organized security markets. Shareholders rarely involved in management. Closely Held Corporation Few shareholders. Shareholders may have buy-and-sell agreements. Shareholders often involved in management.

15. Professional Corporation A corporation formed by lawyers, doctors, or other professionals. E.g., P.C., P.A., S.C. Shareholders called members. Members not usually liable for torts committed by agents or employees. May be liable for malpractice of members.

16. Types of Corporations

17. Selecting a State for Incorporating A corporation can be incorporated in only one state. May choose state where business is located. May choose state where laws are most favorable to operations. E.g., Delaware. Can do business in all other states in which it qualifies to do business.

18. Selecting Corporate Name Must contain corporation, company, incorporated, or limited. Must not mislead regarding company’s purpose. Must not infringe on another’s trademark. Must not be similar to other non-trademarked names. Consider whether domain name available.

19. Incorporators The person or persons, partnerships, or corporations that are responsible for incorporation of a corporation. Primary duty is to sign the articles of incorporation.

20. Promoter A person or persons who: Organize and start the corporation. Negotiate and enter into contracts in advance of its formation. E.g., leases, contracts to buy real and personal property, employment contracts. Find the initial investors to finance the corporation.

21. Promoters’ Liability Promoters often enter into contracts on behalf of the corporation prior to its actual incorporation. If the corporation never comes into existence, the promoters have joint personal liability on the contract, unless the third party specifically exempts them from such liability.

22. Promoters’ Liability(continued) If the corporation is formed, it becomes liable on a promoter’s contract only if it agrees to become bound to the contract. The promoter remains liable on the contract unless the parties enter into a novation.

23. Articles of Incorporation Basic governing document of the corporation. Must be filed with secretary of state of state of incorporation. Contains name of corporation, number of shares authorized, name and address for registered agent and incorporators. May contain term, purpose, limitations, regulations of affairs.

24. Amending the Articles Can be amended to contain any provision that could have been lawfully included in the original document. Amendment must show that: board adopted resolution recommending amendment; and shareholders voted to approve. Filed with secretary of state.

25. Corporate Status RMBCA provides that corporate existence begins when the articles of incorporation are filed. Filing of articles is conclusive proof that a corporation exists. After that, only the state can challenge status of the corporation. Failure to file articles is conclusive proof that corporation does not exist.

26. Purpose Can be formed for any legal purpose. General-purpose clause often included in the articles of incorporation, authorizing the corporation to engage in any activity permitted corporations by law. Alternative is limited-purpose clause. E.g., “to engage in the purpose of real estate development.”

27. Registered Agent A person or corporation empowered to accept service of process on behalf of the corporation. Articles must identify registered office with designated resident agent in state of incorporation.

28. Corporate Bylaws A detailed set of rules adopted by the board of directors after the corporation is incorporated. Contains provisions for managing the business and the affairs of the corporation. Governs internal management structure. E.g., time and place of annual shareholders meeting, notice required for meeting, etc. Board of directors may amend.

29. Corporate Seal A design containing the name of the corporation and the date of incorporation. Imprinted by the corporate secretary using a metal stamp on certain legal documents.

30. Organizational Meeting A meeting held by the initial directors of the corporation after the articles of incorporation are filed. Directors adopt bylaws, elect officers, transact business. E.g., hire employees, select bank and auditor, form committees of board, fix salaries, etc.

31. Statutory Close Corporations (SCCs) Corporations with 50 or fewer shareholders may choose this status. 2/3 shareholders must elect this status. SCC may dispense with some formalities of operating a corporation. E.g., may not have a board of directors, bylaws, or annual meetings.

32. C Corporations Corporations are separate legal entities. They generally must pay corporate income taxes to federal and state governments. If a corporation distributes its profits to shareholders in the form of dividends, shareholders must pay personal income tax on the dividends. This double taxation of corporations is a disadvantage of doing business.

33. S Corporations Some corporations and their shareholders can avoid double taxation by electing to be an S Corporation. S Corporations pay no federal income tax at the corporate level. Corporation’s income or loss flows to the shareholders’ individual income tax returns.

34. Eligibility to be S Corporation Domestic corporation. Not member of affiliated group of corporations. No more than 100 shareholders. No partnerships or corporations as shareholders. Only U.S. citizens or residents as shareholders. Only one class of stock.

35. Equity Securities Common Stock – represents the residual value of the corporation. Common stock has no preferences. Common stock does not have a fixed maturity date. Corporations may issue different classes of common stock. Common shareholders have limited liability. Common shareholders have right to vote.

36. Equity Securities(continued) Preferred Stock–given certain preferences and rights over common stock. Preferred stock can be issued in classes or series. May be redeemable at some future date. Preferred shareholders have limited liability. Preferred shareholders generally have no right to vote.

37. Preferred Stock(continued) Dividend preference Liquidation preference Cumulative dividend right Right to participate in profits Conversion right

38. Types of Shares

39. Debt Securities Debenture – Long-term unsecured debt instrument based on the corporation’s general credit standing. Bond – Long-term debt security secured by some form of collateral. Note – Debt security with a maturity of five years or less. Indenture Agreement– Contract between the corporation and the holder that contains the terms of debt security.

40. Attractive States for Incorporation Delaware Favorable to large corporations. Poison pills making takeovers difficult. Court of Chancery to hear business cases; favorable precedents. Nevada No state taxes on corporate income, franchises, personal income. Assets hard for creditors to reach. Special business court.

41. Express Powers of Corporation Generally, a corporation has the power to: Purchase, own, lease, sell, mortgage, or otherwise deal in real and personal property Make contracts Lend and borrow money Incur liabilities Issue notes, bonds, and other obligations Invest and reinvest funds Sue and be sued in its corporate name

42. Implied Powers of Corporation Powers beyond express powers that allow a corporation to accomplish its corporate purpose. E.g., a corporation has the implied power to open a bank account. E.g., a corporation has the implied power to reimburse its employees for expenses.

43. Ultra Vires Act Act by a corporation that is beyond its express or implied powers. Remedies available if an ultra vires act is committed: Shareholders seek injunction. Corporation sues officers or directors who caused the act for damages. Attorney general of the state of incorporation seeks injunction or to dissolve the corporation.

44. Dissolution of Corporations Voluntary Dissolution Administrative Dissolution Judicial Dissolution

45. Voluntary Dissolution If corporation has not commenced business or issued shares, dissolved by majority vote of incorporators or board. If it has started business, board of directors must recommend, and majority of shares must vote to dissolve. Articles of dissolution must be filed with secretary of state.

46. Administrative Dissolution Secretary of state will administratively dissolve corporation if: Failed to file annual report Failed to maintain registered agent for 60 days Failed to file change of registered agent Did not pay franchise fee Period of duration stated in articles has expired Secretary issues a certificate of dissolution.

47. Judicial Dissolution Instituted by attorney general of state of incorporation Procured articles through fraud Exceeded or abused authority Decree of dissolution issued

48. Winding-up and Liquidation The process by which a dissolved corporation’s assets are collected, liquidated, and distributed to: Creditors Shareholders Other claimants

49. Termination The ending of a corporation that occurs only after the: Winding-up of the corporation’s affairs Liquidation of its assets Distribution of the proceeds to the claimants