Corporations

1. BUSINESS LAW TODAYEssentials 9th 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 steps are involved in bringing a corporation into existence? • In what circumstances might a court disregard the corporate entity (“pierce the veil”) and hold shareholders personally liable? • What are the duties of corporate directors and officers? • What is a voting proxy? What is cumulative voting? • What are the differences between a merger, a consolidation, and a share exchange?

3. The Nature of the Corporation • A corporation is a legal entity, 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).

4. Corporate Personnel • Board of Directors: manage the big picture, set policy, hire officers. • Officers: manage the day-to-day operations of the corporation.

5. 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.

6. 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.

7. 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.

8. Corporate Earnings and 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. • Taxation: Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level. • Holding Companies: used to defer U.S. income taxes (hold shares of another).

9. 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.

10. 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.

11. Classification of Corporations • Public and Private. • Nonprofit. • Close Corporations. • Shares held by family members or very few shareholders. Management is information, similar to a partnership. • Transfer of shares is restricted. • Misappropriation of Funds is a major issue. • CASE 20.1Williams v. Stanford. (2008). Two minority shareholders prevented one 70% shareholder from transferring of corporate assets after proving abuse and fraud.

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. Corporate Formation and Powers • The process of incorporation generally involves two steps: • Promotional Activities; and • The Legal Process of Incorporation.

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

15. Selecting the State • 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 (and maybe the promoters).

16. Securing the Corporate Name • 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. Preparing the Articles of Incorporation • 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.

18. Preparing the Articles of Incorporation • 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.

19. 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.

20. 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.

21. Corporation by Estoppel • Corporation By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists. • CASE 20.2Brown v. W.P. Media, Inc. (2009). Firm that represented itself as a corporate entity is estopped from denying liability for breach of contract even if it was did not exist at the time of the contract.

22. Piercing the Corporate Veil • “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. • Factors a court considers: • 3rd party tricked into dealing with a corporation rather than the individual. 

23. Issues: Piercing the Corporate Veil • Was corporation set up to not make a profit, remain insolvent, or be under capitalized? • Were statutory formalities followed? • Was the corporation an “alter ego” of a majority shareholder, with personal and corporate interests commingled such that the corporation has no separate identity?

24. Corporate Financing

25. Bonds

26. 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.

27. Venture Capital and Private Equity Capital • Venture Capital: start-up businesses and high-risk enterprises need start-up and expansion capital. The start-up typically gives a share of its stock. • Private Equity Capital: obtain capital from wealthy investors. Ultimately, the company may sell shares in an IPO. • Locating potential investors online.

28. Roles of 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.

29. Election and Compensation 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). • In very large companies, directors can be compensated, and may be officers as well.

30. 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.

31. Rights of Directors • 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.

32. Committees of the Board of Directors • With large numbers of directors, various sub-committees can be formed: • Executive Committee. • Audit Committee. • Nominating Committee. • Compensation Committee. • Litigation Committee.

33. 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.

34. 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.

35. 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. • 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.

36. Duty of Loyalty • 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. • CASE 20.3Guth v. Loft, Inc. (1939). Guth violated his fiduciary duty by acquiring the Pepsi-Cola trademark for himself, putting himself in a competitive position with the company he worked for.

37. 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.

38. 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.

39. Role of 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.

40. 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.

41. Shareholders’ 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.

42. 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. Cumulative Voting: allows minority shareholders to get a board member elected. Shareholder Voting

43. 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.

44. 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.

45. 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. • What are “illegal dividends”?

46. 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.

47. 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.

48. 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.

49. The 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.

50. Duties and Liabilities 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 hasn’t paid for stock pursuant to the stock subscription agreement. • Shareholder buys “watered stock” which is below the stock’s par value.