corporate formation and financing

Chapter Seven

Corporate Formation and Financing

Business Organizations for ParalegalsReed and Cheeseman

© 2012 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights Reserved.2 29 - 235 - 2

Chapter Seven – Objectives

1. Define corporation and list the major characteristics of a corporation.

2. Describe the process of forming a corporation.

3. Describe promoters’ liability.

4. Define common stock and preferred stock.

5. Define S corporation and describe the tax benefits of this form of corporation.



CorporationCorporation

A fictitious legal A fictitious legal entity that is created entity that is created according to statutory according to statutory requirements.requirements.



Nature of the Corporation

Corporations are a product of the state.

Corporations Codes – State statutes that regulate the formation, operation, and dissolution of corporations.

Courts interpret state corporation statutes to decide individual corporate and shareholder disputes.



The Corporation as a Legal “Person”

A corporation is a separate legal entity (or legal person).

Corporations can: Sue or be sued in their own names. Enter into and enforce contracts. Hold title to and transfer property. Be found civilly and criminally liable for

violations of law.



Characteristics of Corporations

Limited Liability Limited Liability of Shareholdersof Shareholders

Free Free Transferability of Transferability of

SharesShares

Perpetual Perpetual ExistenceExistence

Centralized Centralized ManagementManagement



Limited Liability of Shareholders

Shareholders are only liable to the extent of their capital contributions for the contracts and debts of their corporation.

Are not personally liable for the contracts and debts of the corporation.



Free Transferability of Shares

Corporate shares are freely transferable by the shareholder. May sell, assign, pledge, or gift. Unless issued pursuant to certain exceptions from

securities registration.

Shareholders may agree among themselves on restriction on the transfer of shares.



Perpetual Existence

Corporations exist in perpetuity Unless specific duration is stated in articles of

incorporation. Can be voluntarily terminated by the

shareholders. May be involuntarily terminated by the

corporation’s creditors .



Centralized Management

Board of directors makes policy decisions concerning the operation of the corporation.

Members of the board of directors are elected by the shareholders.

Directors appoint corporate officers to run the corporation’s day-to-day operations. Directors and the officers form the corporate

“management.”



Revised Model Business Corporation Act (RMBCA)

Model Business Corporation Act (MBCA) Model act drafted in 1950 Was intended to provide a uniform law for

regulation of corporations Revised Model Business Corporation Act

(RMBCA) 1984 revision of the MBCA Many states have adopted all or part of the

RMBCA



There is no general federal There is no general federal corporations law governing the corporations law governing the formation and operation of formation and operation of private corporations.private corporations.

Many federal laws regulate the Many federal laws regulate the operation of private operation of private corporations.corporations.



Public v. Private

Public Corporation A corporation formed to meet a specific

governmental or political purpose. Private Corporation

A corporation formed to conduct privately owned business.



Profit v. Nonprofit

Profit Corporation A corporation created to conduct a business for

profit. Can distribute profits to shareholders in the form of

dividends. Nonprofit Corporation

A corporation that is formed to operate charitable institutions, colleges, universities, and other not-for-profit entities.



Publicly Held v. Closely Held

Publicly Held Corporation A corporation that has many shareholders. It’s securities are traded on organized security

markets. Closely Held Corporation

A corporation owned by few shareholders. Shareholders often involved in management. Shareholders may have buy-and-sell agreements



Professional Corporation

A corporation formed by lawyers, doctors, or other professionals.

Shareholders called members. Members not usually liable for torts committed

by members or agents Liability usually imposed for malpractice of

members.



Selecting a State for Incorporating a Corporation

A corporation can be incorporate in only one state.

Can do business in all other states which it qualifies to do business.

Directors and the shareholders must consider the corporations law of state.



Types of Corporations

Type of Corporation

Description

Domestic A corporation is a domestic corporation in the state in which it is incorporated

Foreign A corporation is a foreign corporation in states other than the one in which it is incorporated

Alien A corporation is an alien corporation in the United States if it is incorporated in another country.



Incorporation Procedures

Corporations are creatures of statute.

The organizers of the corporation must comply with the state’s incorporation statute to form a corporation.

A corporation can be incorporated in only one state.

It can do business in all other states in which it qualifies.



Incorporators

The person or persons, partnerships, or corporations that are responsible for incorporation of a corporation.

Primary duty is to sign the articles of incorporation.



Promoter

A person or persons who: Organize and start the corporation Negotiate and enter into contracts in advance of its

formation Find the initial investors to finance the corporation



Promoters’ Liability

Promoters often enter into contracts on behalf of the corporation prior to its actual incorporation.

If the corporation never comes into existence, the promoters have joint personal liability on the contract, unless the third party specifically exempts them from such liability.



Promoters’ Liability(continued)

If the corporation is formed, it becomes liable on a promoter’s contract only if it agrees to to become bound to the contract.

The promoter remains liable on the contract unless the parties enter into a novation.



Articles of Incorporation

The basic governing documents of the corporation. Must be filed with the secretary of state of

the state of incorporation. Contains name of corporation, number of

shares authorized, name and address for registered agent and incorporators.

May contain term, purpose, limitations, regulations of affairs.



Amending the Articles

Can be amended to contain any provision that could have been lawfully included in the original document.

Must show that the board adopted resolution recommending amendment

Shareholders voted to approve Filed with secretary of state



Corporate Status

The RMBCA provides that corporate existence begins when the articles of incorporation are filed. The filing of the articles of incorporation is

conclusive proof that a corporation exists. After that, only the state can challenge the

status of the corporation. Third parties cannot thereafter challenge the

existence of the corporation.



Purpose

Can be formed for any legal purpose.

General-Purpose Clause is often included in the articles of incorporation that authorizes the corporation to engage in any activity permitted corporations by law.



Registered Agent

A person or corporation that is empowered to accept service of process on behalf of the corporation.

Must be identified in the article

Must have office in state.



Corporate Bylaws

A detailed set of rules adopted by the board of directors after the corporation is incorporated. Contains provisions for managing the business and

the affairs of the corporation. Govern internal management structure. Board of directors may amend.



Corporate Seal

A design containing the name of the corporation and the date of incorporation. It is imprinted by the corporate secretary

using a metal stamp on certain legal documents.



Organizational Meeting

A meeting held by the initial directors of the corporation after the articles of incorporation are filed.

Directors adopt bylaws, elect officers, transact business.



S Corporations

Corporations are separate legal entities. They generally must pay corporate income taxes to

federal and state governments. If a corporation distributes its profits to shareholders

in the form of dividends, shareholders must pay personal income tax on the dividends.

This double taxation of corporations is a disadvantage of doing business.



S Corporations(continued)

Some corporations and their shareholders can avoid double taxation by electing to be an S Corporation.

If a corporation elects to be taxed as an S Corporation, it pays no federal income tax at the corporate level.

The corporation’s income or loss flows to the shareholders’ individual income tax returns.

Election is made by filing IRS Form 2553.



Financing the Corporation

A corporation needs to finance the operation of its business. Equity securities (or stocks) – represent ownership

rights in the corporation. Debt securities – establish a debtor-creditor

relationship in which the corporation borrows money from the investor to whom the debt security is issued.



Equity Securities

Common Stock – A type of equity security that represents the residual value of the corporation. Common stock has no preferences. Common stock does not have a fixed maturity date. Corporations may issue different classes of

common stock. Common shareholders have limited liability.



Equity Securities(continued)

Preferred Stock – A type of equity security that is given certain preferences and rights over common stock. Preferred stock can be issued in classes or series. One class of preferred stock can be given

preferences over another class of preferred stock. Preferred shareholders have limited liability.



Preferred Stock

Dividend Dividend PreferencePreference Liquidation Liquidation

PreferencePreference

Cumulative Cumulative Dividend RightDividend RightRight to Right to

Participate in Participate in ProfitsProfits

Conversion Conversion RightRight



Preferred Stock(continued)

Dividend preference Liquidated preference Cumulative dividend right Noncumulative dividend rights Participating preferred Nonparticipating preferred Convertible preferred Nonconvertible preferred Redeemable preferred Nonredeemable preferred



Types of Shares

Type of Share Description

Authorized Shares authorized in the corporation’s articles of incorporation.

Issued Shares sold by the corporation.

Treasury Shares repurchased by the corporation. They do not have the right to vote.

Outstanding Shares of stock that are in shareholder hands. These shares have the right to vote.



Debt Securities

Debenture – A long-term unsecured debt instrument that is based on the corporation’s general credit standing.

Bond – A long-term debt security that is secured by some form of collateral.

Note – A debt security with a maturity of five years or less.

Indenture Agreement- A contract between the corporation and the holder that contains the terms of debt security.



Express Powers of a Corporation A corporation has the same basic rights to perform

acts and enter into contracts as a physical person. A corporation’s express powers are found in:

(1) The U.S. Constitution(2) State constitutions(3) Federal statutes(4) State statutes(5) Articles of incorporation(6) Bylaws(7) Resolutions of the board of directors.



Express Powers of a Corporation(continued)

Generally, a corporation has the power to: Purchase, own, lease, sell, mortgage, or otherwise

deal in real and personal property Make contracts Lend and borrow money Incur liabilities Issue notes, bonds, and other obligations Invest and reinvest funds Sue and be sued in its corporate name



Implied Powers of a Corporation

Powers beyond express powers that allow a corporation to accomplish its corporate purpose. e.g., a corporation has the implied power to open a

bank account e.g., a corporation has the implied power to to

reimburse its employees for expenses



Ultra Vires Act

An act by a corporation that is beyond its express or implied powers.

Remedies available if an ultra vires act is committed:

1. Shareholders can sure for an injunction.2. The corporation can sue the officers or directors who

caused the act for damages.3. The attorney general of the state of incorporation can

bring an action to enjoin the act or to dissolve the corporation.



Dissolution of Corporations

Voluntary Voluntary DissolutionDissolution

Administrative Administrative DissolutionDissolution

Judicial DissolutionJudicial Dissolution



Voluntary Dissolution

If corporation has not commenced business or issued shares Dissolved by majority vote of incorporators

or board If it has started business

Board of directors must recommend and majority of shares must be voted to dissolve

Articles of dissolution must be filed with secretary of state



Administrative Dissolution

Secretary of state will administratively dissolve corporation if: Failed to file annual report Failed to maintain registered agent for 60 days Failed to file change of registered agent Did not pay franchise fee Period of duration stated in articles has expired

Secretary issues a certificate of dissolution



Judicial Dissolution

Instituted by attorney general of state of incorporation Procured articles through fraud Exceeded of abused authority

Decree of dissolution issued



Winding-up and Liquidation

The process by which a dissolved corporation’s assets are collected, liquidated, and distributed to: Creditors Shareholders Other claimants



Termination

The ending of a corporation that occurs only after the: Winding-up of the corporation’s affairs Liquidation of its assets Distribution of the proceeds to the claimants



Chapter Seven – Recap

1. Define corporation and list the major characteristics of a corporation.

2. Describe the process of forming a corporation.

3. Describe promoters’ liability.

4. Define common stock and preferred stock.

5. Define S corporation and describe the tax benefits of this form of corporation.

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