corporate formation and financing chapter 32. the nature and classification of corporations a...

Corporate Formation and Financing

Chapter 32

The Nature and Classification of Corporations

• A corporation is a creature of statute, an

artificial “person.”• Corporations can have one or more

shareholders, comprised of natural persons or other businesses.

The Nature and Classification of Corporations

• A corporation is a legal “person” and enjoys the same rights and privileges as a natural person:

•Access to court systems. •Constitutional guarantees of free speech, due process, and freedom from unreasonable search and seizures.

The Nature and Classification of Corporations

• Corporate Personnel. –Responsibility for management of

company rests with board of directors (elected by shareholders).

–Board of directors makes policy decisions and hires officers to run corporation on a daily basis.

The Nature and Classification of Corporations

• Corporate Personnel. –Shareholders can sue corporation and be

sued by corporation and bring a derivative suit on behalf of the corporation in some instances.

The Nature and Classification of Corporations

• Limited Liability of Shareholders.–Generally, shareholders are not personally

liable for corporate acts.–But in certain situations, the corporate

“veil” of limited liability can be pierced, holding the shareholders personally liable.

The Nature and Classification of Corporations

• Corporate Earnings and Taxation.–Profits can either be kept as retained

earnings or passed on to the shareholders as dividends.

–Corporate Taxation: can be taxed twice, first to corporation, then to shareholders via dividends.

The Nature and Classification of Corporations

• Torts.–Under respondeat superior, liability for

torts committed by agents within the course and scope of their employment

The Nature and Classification of Corporations

• Criminal Acts.–A corporation can be liable for criminal

acts, but cannot be imprisoned, only fined.

–However, under the ‘responsible officer’ doctrine, corporate officers may go to prison.

The Nature and Classification of Corporations

• Classification of Corporations.–Domestic corporation does business

within its state of incorporation.–Foreign corporation from in X state,

doing business in Z state. –Alien Corporation: formed in another

country.

The Nature and Classification of Corporations

• Classification of Corporations.–Public and Private Corporations.–Nonprofit Corporations.–Closely Held Corporations

•Shares held by few shareholders.•More informal management, similar to a partnership.

The Nature and Classification of Corporations

• Classification of Corporations.–Closely Held Corporations

•Management of Closely Held Corporations.

•Transfer of Shares. •Shareholder Agreement to Restrict Stock Transfers.

The Nature and Classification of Corporations

• Classification of Corporations.–Closely Held Corporations

•Misappropriation of Closely Held Corporation Funds.

The Nature and Classification of Corporations

• Classification of Corporations.–“S” Corporations:

•Avoids federal “double taxation” of regular corporations at the corporate level.

•Only dividends are taxed to the shareholders as personal income.

The Nature and Classification of Corporations

• Classification of Corporations.–“S” Corporations:

• IRS requirements: Corporation is domestic, fewer than 100 shareholders, only one class of stock, no shareholder can be a non-resident alien.

The Nature and Classification of Corporations

• Classification of Corporations.–Benefit Corporations.

•For-profit corporation that seeks to have a material positive impact on society, but must comply with certain statutory requirements.

• The process of incorporation generally involves two steps:–Preliminary and Promotional Activities;

and –The Legal Process of Incorporation.

Corporate Formation

Corporate Formation

• Promotional Activities. –Before corporation is formed,

promoters are the persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements.

Corporate Formation

• Promotional Activities. –Promoter’s Liability: Promoter is

personally liable for pre-incorporation contracts on behalf of the corporation, unless 3rd party agrees to hold future corporation liable.

Corporate Formation• Incorporation Procedures.

–Select State of Incorporation.–Secure the Corporate Name.

Corporate Formation• Incorporation Procedures.

–Prepare the Articles of Incorporation: which deals with shares, the registered agent and office, incorporators, duration and purpose, and internal organization.

–File the Articles with State.

Corporate Formation• First Organizational Meeting.

–After the corporation is “chartered” (created) it can do business.

–Shareholders should approve the bylaws, elect directors, hire officers and ratify (novation) pre-incorporation contracts and activities.

Corporate Formation

• Improper Incorporation. –De Jure: substantial statutory

requirements are met; cannot be attacked by state or 3rd parties.

Corporate Formation

• Improper Incorporation. –De Facto: statutory requirements not

met, but promoters made good faith effort to comply with corporate law; can only be attacked by state.

Corporate Formation

• Corporation by Estoppel.–If it acts like a corporation, it cannot

avoid liability by claiming that no corporation exists.

–Applies when a third party contracts with corporation but not filed articles of incorporation.

Corporate Powers• Express Powers.

–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.

Corporate Powers• Implied Powers.

–All acts reasonably necessary to accomplish corporate purposes.

–A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the enterprise.

Corporate Powers• Ultra Vires.

–Corporate acts beyond the express or implied powers of the corporation

–Articles of incorporation now adopt very broad purposes to prevent lawsuits against the corporation.

Piercing the Corporate Veil

• In certain situations, courts will “pierce the corporate veil” and hold shareholders personally liable in the interests of justice and fairness.

Piercing the Corporate Veil

• Factors a court considers: –3rd party tricked into dealing with a

corporation rather than the individual.

–Corporation is set up never to make a profit or remain insolvent or is under-capitalized.

Piercing the Corporate Veil

• Factors a court considers: –Corporation is formed to evade an

existing legal obligation.–Statutory formalities are not

followed. –Commingling of personal and

corporate interests or assets.

Piercing the Corporate Veil• A Potential Problem for Closely Held

Corporations.–Separate status must be preserved.–Commingling of funds.–No director meetings.–Shareholder use of corporate property.

Piercing the Corporate Veil• The Alter-Ego Theory.

–Corporation is “alter ego” of majority shareholder and personal and corporate interest are commingled such that the corporation has no separate identity.

Bonds vs. StocksDebt Ownership/equity

Fixed ROI Dividends (variable)

No votes Vote for Management

Optional Required

Priority over stock Paid last

Corporate Financing

Corporate Financing• Bonds.

–Issued by business firms and government at all levels.

–Normally have a maturity date – when principal is returned to investor.

Corporate Financing• Bonds.

–Sometimes referred to as fixed-income securities, because bondholders receive fixed-dollar interest payments.

–Bond indenture: lending agreement.

Corporate Financing• Stocks.

–Common Stock: represents true ownership of a corporation. •Provides pro-rata (proportional) ownership interest reflected in voting, control, earnings and assets.

Corporate Financing• Stocks.

–Common Stock:• Investors who assume a residual financing position (whatever is left may go to dividends to shareholders).

Corporate Financing• Stocks.

–Preferred Stock: has preferences over common stock.•Cumulative Preferred.•Participating Preferred.•Convertible Preferred.•Redeemable or Callable Preferred.

Corporate Formation and Financing

Chapter 32