Chapter 19 Corporations – Flashcards
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The majority of state statutes are guided by the most recent version of the MCBA
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Revised Model Business Corporation Act (RMBCA)
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A legal entity created and recognized by state law. One or more owners (shareholders). Operates under a name distinct from the names of its owners. Its authority to act and the liability for its actions are separate and apart from the individuals who own it. Recognized as a "person" Right of access to the courts as citizens and can sue or be sued. Constitutional rights
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The Nature & Classification of Corporations
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Board of directors, elected by the shareholders, are responsible for the overall management of the firm. They make policy decisions and hires corporate officers and other employees to run the daily business operations.
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Corporate Personnel
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Corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments. However, in certain situations, a court can pierce the corporate veil and impose liability on shareholders for the corporation's obligations.
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The Limited Liability of Shareholders
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When a corporate earns profits, it can either pass them on the shareholders in the form of dividends or retain them as profits (retained earnings). If invested properly, retained earnings will yield higher corporate profits in the future and cause the price of the company's stock to rise. Individual shareholders can make capital gains when they sell their stock.
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Corporate Earnings & Taxation
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Whether a corporation retains its profits or passes them on to the shareholders as dividends, those profits are subject to income tax by various levels of government. The state can suspend the entity's corporate status until the taxes are paid or even dissolve the corporation for failing to pay taxes. Double Taxation
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Corporate Taxation
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The company pays tax on its profits. Shareholders must pay income tax on dividends (unless the dividends represent distributions of capital). Dividends are not tax deductible.
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Double Taxation
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A company whose business activity is holding shares in another company. Established in a low-tax or no-tax offshore jurisdiction. U.S. corporations use holding companies to reduce or defer their U.S. income taxes. Once the profits are brought "onshore", they are taxed at the general corporate income tax rate. Any payments received by the shareholders are taxable at the full U.S. rates
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Holding Company (Parent Company)
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A corporation is liable for the torts committed by its agents of officers within the course and scope of their employment. Respondeat Superior
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Tort Liability
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Under modern criminal law, a corporation may be held liable for the criminal acts of its agents or employees, provided the punishment is one that can be applied to the corporation. Corporations cannot be imprisoned, only fined.
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Criminal Acts
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Depends on its location, purpose, and ownership characteristics
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Classification of Corporations
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In a given state, a corporation that does business in, and is organized under the laws of, that state
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Domestic Corporation
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A corporation formed in one state but doing business in another is referred to in the second state
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Foreign Corporations
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A corporation formed in another country but doing business in the U.S.
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Alien Corporation
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A corporation does not have an automatic right to do business in a state other than its state or incorporation. It must obtain a certificate of authority in any state in which it plans to do business.
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Domestic, Foreign, & Alien Corporations
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Formed by the government to meet some political or governmental purpose Ex. U.S. Postal Service, AMTRAK
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Public Corporation
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Any corporations whose shares are publicly trader in a securities market Ex. NASDAQ
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Publicly Held Corporation (Public Company)
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In contrast to public corporations, private corporations are created either wholly or in part for private benefit (profit). Most corporations are private. Although they may serve a public purpose, they are owned by private persons rather than by a government.
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Public & Private Corporations
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Formed for purposes other than making a profit Allows various groups to own property and to form contracts without exposing the individual members to personal liability. Ex. Private hospitals, charities, religious organizations
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Nonprofit Corporations
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One whose shares are held by members of a family or by relatively few persons. The members of the small group constituting the shareholders of a close corporation are personally known to each other. Because the number of shareholders is so small, there is no trading market for the shares. Operated like a partnership RMBCA gives a close corporation considerable flexibility in determining its rules of operation
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Close Corporations (Closely Held, Family, Privately Held Corporations)
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Resembles that of a sole proprietorship or a partnership, in that a single shareholder or a tightly knit group of shareholders hold the positions of directors and officers. As a corporation, the firm must meet all specific legal requirements set forth in state statutes. To prevent a majority shareholder from dominating the company, a close corporation require that more than a simple majority of the directors approve any action taken by the board.
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Management of Close Corporations
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By definition, a class corporation has a small number of shareholders. Thus, the transfer of one shareholder's shares to someone else can cause serious management problems. The other shareholders may find themselves required to share control with someone they do not know or like. Corporation could restrict the transferability or shares to outside persons. Shareholders could be required to offer their shares to the corporation or the other shareholders before selling them to an outside purchaser.
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Transfer of Shares in Close Corporations
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Control of a close corporation can be stabilized through the use of a shareholder agreement. A shareholder agreement can provide for proportional control when one of the shareholders dies. Agreements between shareholders can also restrict the transfer of a close corporation's stock (existing shareholders have an option to purchase stock before it is sold or transferred to an outside party).
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Shareholder Agreement to Restrict Stock Transfers
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A majority shareholder in a close corporation takes advantage of his or her position and misappropriates company funds. The normal remedy for the injured minority shareholders is to have their shares appraised and to be paid the fair market value for them.
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Misappropriation of Close Corporation Funds
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A close corporation that has met certain requirements as set by the Internal Revenue Code and thus qualified for special income tax treatment. Taxed the same as a partnership, but its owners enjoy the privilege of limited liability
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S Corporations
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1. Be a domestic corporation 2. Not be a member of an affiliated group of corporations 3. Shareholders of the corporation must be individuals, estates, or certain trusts and tax-exempt organizations. 4. No more than 100 shareholders 5. Only one class of stock, although all shareholders do not need to have the same voting rights 6. No shareholder for the corporation may be a non-resident alien
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Important Requirements for S Corporation Status:
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An S corporation is taxed like a partnership, so the corporate income passes through to the shareholders, who pay personal income tax on it (Avoid double taxation). If the corporation has losses, the S election allows the shareholders to use the losses to offset other income.
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Effect of S Election
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Professionals such as physicians, lawyers, dentists, and accountants can incorporation. Identified by P.C. (professional corporation), S.C. (service corporation), P.A. (professional association) Laws governing the formation and operation are similar to ordinary business corporations. Courts hold each professional liable for any malpractice committed within the scope of the business by the others in the firm. Shareholder not liable for torts committed by other professional at the firm
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Professional Corporations
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For-profit corporation that seeks to have a material positive impact on society and the environment.
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Benefit Corporations
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1. Purpose; Although the corporation is deigned to make a profit, its purpose is to benefit the public as a whole 2. Accountability; Shareholders determine whether the company has achieved a material positive impact. Shareholders have a right of private action (benefit enforcement) enabling them to sue the corporation if its fails to pursue or create a public benefit 3. Transparency; Must issue an annual benefit report on its overall performance. Delivered to the shareholder and public
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Benefit corporations differ form traditional corporations in the following three ways:
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Sole proprietorships or partnerships convert to corporate entities as businesses grew and need to obtain additional capital by issuing shared of stock. Many states allow businesses to incorporate via the Internet
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Corporate Formation
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Today, persons incorporating their business rarely engage in preliminary promotional activities. Businesspersons are liable for all preincorporation contracts made with investors, accountants, or others on behalf of the future corporation. Personal liability continues until the newly formed corporation assumes liability for the preincorporation contracts through a novation.
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Promotional Activities
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1. Select a state of incorporation 2. Secure the corporate name 3. Prepare the articles of incorporation 4. File the articles of incorporation with the secretary of state
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Incorporation Procedures
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Because state laws differ, individuals may look for state that offer the most advantageous tax or incorporation procedures. State charges to incorporate Delaware has the least restrictive laws Close corporations generally incorporate in the state where their principal shareholders live and work. Businesses often choose to incorporate in the state in which most of the corporation's business will be conducted
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Select the State of Incorporation
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The choice of a corporation name is subject to state approval to ensure against duplication or deception. State statutes require secretary of state run a check on the proposed name in the state of incorporation. Persons incorporating a firm run a check on the proposed name on the Internet. Once cleared, a name can be reserved for a short time, for a fee, pending the completion of the articles of incorporation. Corporation's name include "Corp." (Corporation), "Inc." (Incorporated), "Co." (Company), "Ltd." (Limited)
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Secure the Corporate Name
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Corporate name should be one that can be used as the business's Internet domain name. Check what domain names are available before securing a corporate name with the state.
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First Check Available Domain Names
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A new corporation's name cannot be the same as the name of an existing corporation doing business within the same state. If a firm does business under a name that is the same as r deceptively similar to an existing company's name, it ma be liable for trade infringement. Also transfer part of the goodwill of 1st corporate user, infringing on the 1st company's trademark rights
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Trade Name Disputes
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The person or persons who execute (sign) the articles are the incorporators. Articles of Incorporation must include: 1. Name of the corporation 2. Number of shares the corporation is authorized to issue 3. Name and street address of the corporation's initial registered agent and registered office (principal office of the corporation) 4. Name and address of each incorporator Do not provide much detail about the firm's operations Perpetual existence unless stated otherwise Formed for any lawful purpose
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Prepare the Articles of Incorporation
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Internal rules of management adopted by the corporation at its first organizational meeting Cannot conflict with the incorporation statute or the articles of incorporation Under the RMBCA, shareholders may amend or repeal the bylaws. Board of directors may also amend or repeal the bylaws unless stated otherwise
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Bylaws
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Once the articles of incorporation have been prepared and signed, they are sent to the appropriate state official (secretary of state) along with the required filing fee. Secretary of state stamps the articles "Filed" and returns the copy of the articles to the incorporators. Once this occurs, the corporation officially exists.
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File the Articles with the State
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After incorporation, the first organizational meeting must be held. If articles of incorporation named the initial board of directors, then the directors, by majority vote, call the meeting to adopt the bylaws and complete the company's organization. If the articles did not name the directors, then the incorporators hold the meeting to elect the directors and adopt bylaws.
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First Organizational Meeting to Adopt Bylaws
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If procedures are not followed precisely, others may be able to challenge the existence of the corporation. Ex. A third party who is attempting to enforce a contract or bring a suit for a tort injury learns of them
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Improper Incorporation
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When a corporation has substantially complied with all conditions precedent to incorporation, the corporation is said to have de jure (rightful and lawful) existence Sometimes, the incorporators fail to comply with all statutory mandates. If the defect is minor, most courts will overlook the defect and find that a corporation (de jure) exists
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De Jure Corporations
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If the defect in formation is substantial, the outcome will vary depending on the jurisdiction. Ex. Corporation's failure to hold an organizational meeting to adopt bylaws Some states treat a corporation as a legal corporation despite the defect in its formation if the following three requirements are met: 1. A state statute exists under which the corporation can be validly incorporated 2. The parties have made a good faith attempt to comply with the statute 3. The parties have already undertaken to do business as a corporation Other states establish a corporation does not legally exist, and the incorporators are personally liable if there is a substantial defect in complying with the incorporation statute.
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De Facto Corporations
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The estoppel doctrine most commonly applies: 1) when a third party contracts with an entity that claims to be a corporation but has not filed articles of incorporation. 2) when a third party contracts with a person claiming to be an agent of a corporation that does not in fact exist When justice requires, courts in some states will treat an alleged corporation as if it were an actual corporation for the purpose of determining the rights and liabilities in particular circumstances
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Corporation by Estoppel
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When a corporation is created, the express and implied powers necessary to achieve its purpose come into existence. After the bylaws are adopted, the corporation's board of directors will pass resolution that grant or restrict corporate powers
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Corporate Powers
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1. U.S. Constitution 2. State constitutions 3. State statutes 4. The articles of incorporation 5. Bylaws 6. Resolutions of the board of directors
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The following order of priority is used if a conflict arises among the various documents involving a corporation
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In the absence of express constitutional, statutory, or other prohibitions, the corporation has the implied power to perform all acts reasonably necessary to accomplish its corporate purposes. A corporation has the implied power to borrow funds within certain limits, lend funds, and extend credit to those with whom it has a legal or contractual relationship. To borrow fund, the corporation acts through its board of directors to authorize the loan. A corporate officer does not have the authority to bind the corporation to an action that will greatly affect the corporate purpose or undertaking such as the sale of substantial corporate assets.
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Implied Powers
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"Beyond the power" In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts
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Ultra Vires Doctrine
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Most corporations are organized for "any legal business" and do not state a specific purpose, so the ultra vires doctrine has declined in importance. Case that allege ultra vires acts usually involved nonprofit organizations or municipal (public) corporations
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When A Corporations Actions Exceed Its Stated Purpose
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The shareholders can seek an injunction from a court to prevent (or stop) the corporation from engaging in ultra vires acts. The attorney general in the state of incorporation can bring an action to obtain an injunction against the ultra vires transactions or to seek dissolution of the corporation. The corporation or its shareholders (on behalf of the corporation) can seek damages from the officers and directors who were responsible for the ultra vires acts
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Remedies for Ultra Vires Act
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In some situations, the courts will ignore the corporate structure and pierce the corporate veil, exposing the shareholders to personal liability. Generally, courts pierce the veil when the corporate privilege is abused for personal benefit or when the corporate business is treated so carelessly that it is indistinguishable from that of a controlling shareholder.
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Piercing the Corporate Veil
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1. A party is tricked or misled into dealing with the corporation rather than the individual 2. The corporation has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities 3. The corporation is formed to evade an existing legal obligation 4. Statutory corporate formalities, such as holding required corporation meetings, are not followed 5. Personal and corporate interests are mixed together to such an extent that the corporation has no separate identity Courts will scrutinize the transaction closely if the loan comes from an officer, director, or majority shareholder. Loans from persons who control the corporation must be made in good faith and for fair value
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Factors That Lead Courts To Pierce the Corporate Veil
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The potential for corporate assets to be used for personal benefit is especially great in a close corporation. Certain practices invite trouble for the one-person of family-owned (close) corporation, including any of the following: 1. The commingling of corporate and personal funds 2. The failure to hold board of directors' meetings and record the minutes 3. The shareholders' continuous personal used of corporate property (company-owned vehicles)
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A Potential Problem for Close Corporations
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Courts pierce the corporate veil under the theory that the corporation was not operated as a separate entity, but was just another side (or alter-ego) of the individual or group that actually controlled the corporation. Applied when a corporation is so dominated and controlled by an individual or group that the separate identities of the person (or group) and the corporation are no longer distinct Courts use the alter-ego theory to avoid injustice or fraud that would result if wrongdoers were allowed to hide behind the protection of limited liability
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The Alter-Ego Theory
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Corporate directors, officers, and shareholders all play different roles within the corporate entity.
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Directors and Officers
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Directors has responsibility for all policymaking decision necessary to the management of all corporate affairs. The directors must act as a body in carrying out routine corporate business. The board selects and removes the corporate officers, determines the capital structure of the corporation, and declares dividends. Each directors has one vote, and customarily the majority rules. Directors are sometimes characterized as agents because they act on behalf of the corporation. No individual director can act as an agent to bind the corporation. As a group, directors collectively control the corporation in a way that no agent is able to control a principal. Few qualifications include minimum age & residency requirements. May be a shareholder, but that is not necessary (unless the articles require ownership interest)
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The Roles of Directors and Officers
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Number of directors is set forth in the corporations' articles or bylaws. Historically, the minimum has been three, but today many states permit fewer. The incorporators appoint the first board of directors. The initial board serves until the first annual shareholders' meetings. Subsequent directors are elected by a majority vote of the shareholders. Directors usually serve a one-year term, although the term can be longer.
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Election of Directors
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A director can be removed for cause--that is, for failing to perform a required duty--either as specified in the articles of bylaws or by shareholder action. The board of directors may have the power to remove a director for cause, subject to shareholder review
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Removal of Directors
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Vacancies occur on the board if a director dies or resigns or when a new position is created through amendment of the articles or bylaws Either the shareholders or the board itself can fill the vacant position, depending on state law or the provisions of the bylaws. Even when an election appears to be authorized by the bylaws, a court can invalidate the results if the directors were attempting to manipulate the election in order to reduce the shareholders' influence.
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Vacancies on the Board
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Directors are paid at least nominal sums and receive more substantial compensation in large corporations because of the time, work, effort, and especially risk involved. Most states permit the corporate articles or bylaws to authorize compensation for directors. RMBCA states that unless the articles or bylaws provide otherwise, the board itself can set the directors' compensation Directors receive compensation in their managerial positions.
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Compensation of Directors
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A director who is also an officer of the corporation
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Inside Director
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A director who does not hold a management postion
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Outside Director
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The board of directors conducts business by holding formal meetings with recorded minutes. Special meetings can be called, with notice sent to all directors. Most states allow directors to have a meeting via telephone, Skype, provided that all the directors can hear each other during the meeting
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Board of Directors' Meetings
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Unless the articles of incorporation or bylaws specify a greater number, a majority of the board of directors normally constitutes a quorum
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Quorum of Directors
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The minimum number of members of a body of officials or other group that must be present for business to be validly transacted Can be set less than a majority but not less than 1/3 of the directors
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Quorum
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Once a quorum is present, the directors transact business and vote on issues affecting the corporation. Each director present at the meeting has one vote
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Voting
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The board of large, publicly held corporations typically create committees of directors and delegate certain tasks to these committees. By focusing on specific subjects, committees can increase the efficiency of the board. Executive committee handles interim management decisions between board meetings. Does not have the power to declare dividends, amend the bylaws, or authorize the issuance of stock Audit committee is responsible for the selection, compensation, and oversight of the independent public accountants that audit the firm's financial records
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Committees of the Board of Directors
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1.Right to Participate; Because the dates of regular board meetings are specified in the bylaws, no notice of these meetings is required 2.Right of Inspection; Each director can access the corporation's books and records, facilities, and premises. 3.Right to Indemnification; When a director becomes involved in litigation by virtue of her or his position or actions, the director may also have a right to reimbursement for the legal costs, fees, and damages incurred.
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Rights of Directors
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Hired by the board of directors. Most corporations have a president, one or more vice presidents, a secretary, and a treasurer. An individual can hold more than one office and can be both an officer and a director of the corporation Corporate and managerial officers act as agents of the corporation. Rights are defined by employment contracts. Board of directors can remove a corporate officer at any time with or without just cause. If removal of an officer was violating the terms of the employment contract, the corporation is liable for breach of contract
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Corporate Officers and Executive Employees
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Considered to be fiduciaries of the corporation because their relationship with the corporation and its shareholders is one of trust and confidence. Duty of Care Duty of Loyalty
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Duties and Liabilities of Directors and Officers
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1. Act in good faith (honestly) 2. Exercise the care that an ordinarily prudent (careful) person would exercise in similar circumstances 3. Do what she or he believes is in the best interests of the corporation If directors or officers fail to exercise due care and the corporation or its shareholders suffer harm as a result, the directors or officers can be held liable for negligence
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Duty of Care
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Directors and officers are expected to be informed on corporate matters and to conduct a reasonable investigation of the relevant situation before making a decision. Directors and officers must investigate, study, and discuss matters and evaluate alternatives before making a decision. Entitled to rely on information given to them by certain other persons. The reliance must be in good faith to protect a director from liability if the information later proves to be inaccurate or unreliable
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Duty to Make Informed Decisions
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Directors are expected to exercise a reasonable amount of supervision when they delegate work to corporate officers and employees
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Duty to Exercise Reasonable Supervision
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An individual director disagrees with the majority's vote. Unless a dissent is entered in the minutes, the director is presumed to have assented. If the directors are later held liable for mismanagement as a result of a decision, dissenting directors are not held individually liable to the corporation.
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Dissenting Directors
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A corporate director or officer will not be liable to the corporation or to its shareholders for honest mistakes of judgment and bad business decisions.
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The Business Judgment Rule
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As long as the director or officer: 1. Took reasonable steps to become informed about the matter 2. Had a rational basis for her of his decision 3. DId not have a conflict of interest between her or his personal interest and that of the corporation
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When the Rule Applies
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Unless there is evidence of bad faith, fraud, or a clear breach of fiduciary duties, most courts will apply the rule and protect directors and officers who make bad business decisions from liability for those choices.
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Provides Broad Protections
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Faithfulness to one's obligations and duties Directors cannot use corporate funds or confidential corporate information for personal advantage and must refrain from self-dealing
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Duty of Loyalty
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1. Competing with the corporation 2. Usurping (taking personal advantage of) a corporate opportunity 3. Pursing an interest that conflicts with that of the corporation 4. Using information that is not available to the public to make a profit trading securities 5. Authorizing a corporate transactions that is detrimental to minority shareholders 6. Selling control over the corporation
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Cases dealing with the duty of loyalty typically involve one or more of the following:
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Directors are prevented from entering into or supporting businesses that operate in direct competition with corporations on whose boards they serve. Fiduciary duty requires a director or officer to make a full disclosure of any potential conflicts of interest that might arise in any corporate transaction and must abstain from voting to the proposed transaction.
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Conflicts of Interest
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Held liable for negligence in certain circumstances Held liable for crimes and torts committed by themselves or by corporate employees under their supervision If shareholders perceive that the corporate directors are not acting in the best interests of the corporation, they may sue the directors (shareholder's derivative suit) on behalf of the corporation. Held personally liable under a number of statutes, such as statutes enacted to protect consumers or environment.
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Liability of Directors and Officers
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Own the corporation Have an equitable (ownership) interest in the firm Have no responsibilities for the daily management of the corporation, ultimately responsible for choosing the board of directors, which does have such control Corporate officers and other employees owe no direct duty to individual shareholders The duty of officers and directors is to act in the best interests of the corporation and its shareholders as a whole
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Shareholders
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Shareholder approval normally is required to amend the articles of incorporation or bylaws, to conduct a merger or dissolve the corporation, and to sell all or substantially all of the corporation's assets Power to elect or remove members of the board of directors The first board of directors is either named in the articles of incorporation or chosen by the incorporators to serve until the first shareholders' meeting. From that time on, selection and retention of directors are exclusively shareholder functions Shareholders have the inherent power to remove a director from office for cause (breach of duty or misconduct) by a majority vote
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Shareholders' Powers
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Must occur at least annually
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Shareholders' Meetings
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A corporation must notify its shareholders of that date, time, and place of an annual or special shareholders' meeting at least ten days, but not more than sixty days, before the meeting date (specified in the bylaws) Notice of a special meeting must include a statement of the purpose of the meeting, and business transacted at the meeting is limited to that purpose RMCBA does not specify how the notice must be given, but most corporations specify in their bylaws the acceptable methods of notifying shareholders about meetings
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Notice of Meetings
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Law allows stockholders with a few shares of stock to appoint another person as their agent to vote their shares at the meeting. The signed appointment form or electronic transmission authorizing an agent to vote the shares is called a proxy (to manage or take care of) Groups of shareholders have used proxies as a device for taking over a corporation Proxies are revocable unless they are specifically designed as irrevocable and coupled with an interest (person receiving proxies form shareholders agree to buy their shares. Under RMBCA proxies are valid for eleven months, unless the proxy agreement mandates a longer period
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Proxies
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When shareholders want to change a company policy, they can put their ideas up for a shareholder vote. They do this by submitting a shareholder proposal to the board of directors and asking the board to include the proposal in the proxy materials that are sent to all shareholders before meetings
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Shareholders Proposals
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Securities and Exchange Commission (SEC) requires all publicly held companies distribute electronic proxy (e-proxy) materials. Shareholders can permanently elect to receive all future proxy materials on paper or by e-mail with electronic links
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Electronic Proxy Materials
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Unless there is a provision to the contrary, each shareholder is entitled to one vote per share. The articles of incorporation can exclude or limit voting rights, particularly for certain classes of shares
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Shareholder Voting
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For shareholders to act during a meeting, a quorum must be present. A quorum exists when shareholders holding more than 50 percent of the outstanding shares are present, but state laws often permit the articles of incorporation to set higher or lower quorum requirements. A majority vote of the shares present is necessary to pass ordinary matters
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Quorum Requirements
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The corporation prepares the voting list before each shareholders' meeting. Only persons whose names appear on the corporation's stockholder records as owners are entitled to vote Kept at the corporate HQ and must be made available for shareholder inspection
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Voting Lists
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Most states permit, and many require, shareholders to elect directors by cumulative voting, a voting method designed to allow minority shareholders to be represented on the board of directors
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Cumulative Voting
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Each shareholder is entitled to a total number of votes equal to the number of board members elected multiplied by the number of voting shares that the shareholder owns. When cumulative voting is not required by statute or under the articles, the entire board can be elected by a majority of shares at a shareholders' meeting
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Formula
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Before a shareholders' meeting, a group of shareholders can create a shareholder voting agreement by agreeing in writing to vote their shares together in a specified manner, Agreements are valid and enforceable. Corporate managers must be careful that such agreements do not constitute a breach of fiduciary duties
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Shareholder Voting Agreements
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An agreement (trust contract) under which a shareholder assigns the right to vote his or her shares to a trustee, usually for a specified period of time. The trustee is then responsible for voting the shares on behalf of all the shareholders in the trust
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Voting Trust
