Chapter 20

1. BUSINESS LAW TODAYEssentials 8th Ed.Roger LeRoy Miller - Institute for University Studies, Arlington, TexasGaylord A. Jentz - University of Texas at Austin, Emeritus Chapter 20 Corporations

2. 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 important rights of shareholders? • What is the difference between a corporate merger and a corporate consolidation?

3. 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.

4. Constitutional Rights of Corporations • Corporation’s rights (cont’d): • 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.

5. 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.

6. 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.

7. 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. • CASE 20.1Commonwealth v. Angelo Todesca Corp. (2006).

8. 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.

9. Express Corporate Powers • The express powers of a corporation are found in the corporation’s 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 corporation’s express powers.

10. 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.

11. 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.

12. 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.

13. 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.

14. Corporate Formation Select State Secure Name Incorporators File Articles of Incorporation State Charter 1st Organiza-tional Meeting

15. Incorporation Process • 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.

16. Incorporation Process • 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.

17. Corporate Financing

18. Corporate Management: Directors and Officers • Every corporation is governed by a board of directors, and operated by its officers. • 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 an officer and a shareholder, especially in closely-held corporations.

19. 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). • CASE 20.2 Relational Investors, LLC v. Sovereign Bancorp, Inc. (2006).

20. 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.

21. Directors’ Rights and Compensation • 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.

22. Directors’ Management Responsibilities • Declaration and payment of corporate dividends. • Authorization for major corporate policy decisions. • Appointment, supervision and removal of corporate officers. • Financial decisions.

23. 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.

24. 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.

25. Duties and Liabilities of Directors and Officers • Duty of Care (cont’d): • Make informed and reasonable decisions; • Rely on competent consultants and experts; and • Exercise reasonable supervision.

26. 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.

27. 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.

28. 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.

29. 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].

30. 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.

31. 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.

32. Shareholders’ 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.

33. Shareholder’s 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.

34. Shareholder’s 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.

35. 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. Shareholder Voting

36. 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. [Cut off date 70 days ahead of action (notice, dividends, etc..)]

37. 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.

38. Rights of Shareholders • 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.

39. 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.

40. 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.

41. Inspection Rights • 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.

42. Transfer of Shares • 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. • Transfer accomplished by delivery or endorsement to corporate secretary. • New shareholder must be recorded on corporate books.

43. Rights on Dissolution • Shareholders have right to pro-rata share of assets upon liquidation. • 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.

44. Shareholder’s Derivative Suit • Shareholders can sue a 3rd 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. • Any damages recovered go to corporation’s treasury.

45. 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.

46. Merger and Consolidation • Corporations can grow and expand by: • Mergers. • Consolidation. • Purchase of another corporation’s assets. • Purchases of a controlling interest in another corporation.

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

48. Consolidation A B C • 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. • C’s articles of consolidation take the place of the original articles of A and B.

49. Steps for Merger or Consolidation • Step 1: Board of Directors of each corporation involved must approve the merger plan. • Step 2: Shareholders of each corporation must approve. • Step 3: Articles filed with Secretary of State. • Step 4: State issues a certificate of merger to the surviving corporation or a certificate of consolidation to the newly consolidated corporation.

50. Purchase of Assets or Stock • 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.