CHAPTER 20 Corporations

1. CHAPTER 20Corporations

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 of the important rights of shareholders? • What is the difference between a corporate merger and a corporate consolidation? What steps are involved in the termination of a corporate enterprise?

3. 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).

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.

12. 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.

13. 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.

14. 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.

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

16. Promotional Activities • 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.

17. Promoter’s 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”.

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

19. 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.

20. Incorporation Procedures • 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.

21. 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.

22. 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.

23. 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.

24. Corporate Management-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.

25. 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).

26. 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.

27. Role of 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.

28. 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.

29. 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.

30. 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.

31. 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. • In re Cumberland Farms, Inc. (2002).

32. 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.

33. 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].

34. 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.

35. 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.

36. Shareholder 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.

37. Shareholder 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.

38. Shareholder 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.

39. 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

40. 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. Shareholder Voting

41. 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.

42. Shareholders’ Rights • 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.

43. 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.

44. 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.

45. 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.

46. Liability 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 subscription agreement. • Shareholder buys “watered stock” which is below the stock’s par value.

47. 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. • Robbins v. Sanders (2004).

48. 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.

49. A B A Merger • 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.

50. A B C Consolidation • 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.