Legal Recognition of Corporations: Understanding Their Nature and Classification

CHAPTER 19 CORPORATIONS

1. – THE NATURE AND CLASSIFICATION OF CORPORATIONS

A corporation is a legal entity created and recognized by state law. It can consist of one or two persons identified under a common name.

CORPORATE PERSONNEL
When an individual purchases a share of stock in a corporation, that person becomes a shareholder and owner of the corporation. Shareholder and corporations are liable.

THE LIMITED LIABILITY OF SHAREHOLDER
One of the key advantages of the corporate forms is the limited liability of its owners.

Corporate shareholders normally are not personally liable for the obligations of the corporation beyond the extent of their investments.

CORPORATE TAXATION
Corporate profits are taxed, and do not receives tax deduction for dividends distributed to shareholders. Profits that are not distributed are retained by the corporation. These retained earnings if invested properly, will yield higher corporate profits in the future.

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.

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Corporation may be held liable for criminal acts of its agents and employees, provided the punishment is one that can be applied to the corporation, corporation can be fined.

CORPORATION SENTENCING GUIDELINES
Penalties depend on factors and executives involvement. Corporate lawbreakers can face fines smaller amounting or to hundreds of millions of dollars. When a company has taken substantial steps to prevent, investigate, and punish wrongdoing, such as by establishing and enforcing crime prevention standards, a court may impose less serious penalties. Corporate sentencing guidelines require corporations to train employees on how to comply with relevant laws.

CLASSIFICATION OF CORPORATIONS

Domestic, foreign, and alien corporations
* Domestic corporation; by its home state (the state in which it incorporates). * Foreign corporation; corporation formed in one state but doing business in another state. * Alien corporation; corporation formed in another country but doing business on the E.E.U.U.

In some instances, the corporation must obtain a certificate of authority in any state which plans to do business. But the foreign corporation does not need this certificate to sell goods over the internet.

Public and private corporations
* Public corporation, is one formed by the government to meet some political purpose, such a U.S. Postal service, AMTRAK. A public corporation is not the same as a publicly held corporation. A publicly held corporation is any corporation whose shares are publicly traded in a securities market, such as the New York Stock Exchange or over the counter market. * Private corporation, are created for private benefit. Most corporations are private although they may serve a public purpose.

Nonprofit corporation
Corporation formed for purposes other making a profit are called nonprofit or not-for-profit corporations. Private hospitals, educational institutions, charities, and religious organizations for example, are organized as nonprofit organization.

Close corporations
A close corporations is one whose shares are held by members of a family or by relatively few persons. Referred also as closely held, family, or privately held corporations. Usually the members of the small group constituting a close corporation are personally know to each other. A close corporation is often operated like a partnership.

*Management of close corporations
To prevent a majority shareholder from dominating a close corporation, the corporation may require that more than a simple majority of the directors approve any action taken by the board.

*Transfer of shares in close corporations
The transfer of one shareholder’s shares to someone else can cause serious management problems. Control of a close corporation can also be established through the use of shareholder agreement.

S corporations
A close corporation that meets the qualifying requirements specified in subchapter S of the Internal Revenue Code can operate as an S corporation. If a corporation has a S corporation status, it can avoid the imposition of income taxes at the corporate level while retaining many of the advantages of a corporation, particularly limited liability.

*Qualification requirement for S corporations
1) The corporation must be a domestic corporation.
2) The corporation must not be a member of an affiliated group of corporations. 3) The shareholders of the corporation must be individuals, estates, or certain trusts. 4) The corporation must have no more than one hundred shareholders. 5) The corporation must have only one class of stock, although all shareholders do not need to have the same voting rights. 6) No shareholder of the corporation may be a nonresident alien.

*Benefits of a S corporations
1) When a corporation has losses, the S election allows the shareholders to use the losses to offset other taxable income. 2) When the shareholder’s tax bracket is lower than the tax bracket for regular corporations. The S election causes the corporation’s entire income to be taxed in the shareholder’s bracket, whether it is distributed.

Professional corporation
Professional corporation such as physician, lawyers, dentists, and accountants can incorporate. There is generally no limitation on liability for acts of malpractice or obligations incurred because of a breach of duty to a client of a PC. In many states, professional persons are liable not only for their own negligent acts, but also for the misconduct of persons under their direct supervision who render professional services. A shareholder in a professional corporation is generally protected from contractual liability and cannot be held liable for the torts that are committed by other professional at the firm.

2. – CORPORATE FORMATION

One of the most common reasons for creating a corporation is the need for additional capital to finance expansion. Incorporation may be the best choice for an expanding business organization because a corporation can obtain more capital by issuing shares to stock.

PROMOTIONAL ACTIVITIES
Persons rarely engage in preliminary promotional activities. It is important for businesspersons to understand that they are personally liable for all preincorporation contracts made investor, accountants, or others on behalf of the future corporation.

INCORPORATION PROCEDURES
Exact procedures for incorporation differ among states, but the basic steps are as follows: 1) Select a state of incorporation.
2) Secure the corporate name.
3) Prepare the articles of incorporation.
4) File the articles of incorporation with the secretary of state.

Selecting the state of incorporation
Because laws differ from state to state. States fees are considered too.

Securing the corporate name
The choice of a corporate name is subject to state approval to ensure against duplication or deception. All the states require the corporation name to include the word corporation (Corp.), Incorporated (Inc.), company (Co.), or limited (Ltd.).

Preparing the articles of incorporation
The primary document needed to incorporate a business is the articles of incorporation, must include the following information; 1) The name of the corporation.
2) The number of shares the corporation is authorized to issue. 3) The name and address of the corporation’s initial registered agent. 4) The name and address of each incorporator.

*Shares of the corporation
The articles must specify the number of shares of stock the corporation is authorized to issue. A company might state that the aggregate number of shares that the corporation has the authority to issue is 5k.

*Registered office and agent
The corporation must indicate the location and address where of it registered office within the state.

*Incorporators
Each incorporator must be listed by name and address.

*Duration and purpose
A corporation has a perpetual existence unless the articles state otherwise. The owners may want to prescribe a maximum duration, however, after which the corporation must formally renew its existence. A corporation can be formed for any lawful purpose.

*Internal organization
Articles can describe the corporation’s internal management structure, although this is usually included in the bylaws adopted after the
corporation is formed.

Filing the articles with the State
Once the articles of incorporation have been prepared and signed by the incorporators, they are sent to the appropriate state official, usually the secretary of State.

FIRST ORGANIZATIONAL MEETING TO ADOPT BYLAWS
Usually, the most important function of this meeting is the adoption of bylaws. If the articles of incorporation named the initial board of directors, then the directors, by majority vote, call the meeting to adopt the bylaws and complete the company’s organization.

DEFECTS IN FORMATION AND CORPORATE STATUS
The procedures for incorporation are very specific. If they are not allowed precisely, others may be able to challenge the existence of the corporation. When the corporation seeks to enforce a contract against a defaulting party that party may be able to avoid liability on the ground of a defect in the incorporation procedure.

De Jure and De Facto corporations
If a corporation has substantially complied with all conditions precedent to incorporation, a corporation is said to have de jure existence. Because a de jure corporation is one that is properly formed, neither the state nor third party can attack its existence. Sometimes, there is a defect in complying with statutory mandates, under these circumstances the corporation may have de facto status, meaning that it will be treated as a legal corporation despite the defect in its formation. The following elements are required for de facto status;

1) There must be a state statute under which the corporation can be incorporated. 2) The parties must have made a good faith attempt to comply with the statute. 3) The enterprise must already have undertaken to do business as a corporation.

Corporation by Estoppel
If a business holds itself out to others as being a corporation but has made no attempt to incorporate, the firm normally will be stopped from denying corporate status lawsuit by a third party. When justice requires, the courts treat an alleged corporation as if it were an actual corporation for the purpose of determining the rights and liabilities in particular circumstances. A corporation by estoppels is thus determined by the situation. CORPORATE POWERS

When a corporation is created, the express and implied powers necessary to achieve its purpose also come into existence. The following order of priority is used if a conflict arises among the various documents involving a corporation; 1) U. S. Constitution.

2) Constitution of the state of incorporation.
3) State statutes.
4) Articles of incorporation.
5) Bylaws.
6) Resolutions of the board of directors.

To borrow funds, the corporation acts through its board of directors to authorize the loan.

ULTRA VIRES DOCTRINE
The term ultra vires means “beyond the power”. Most cases dealing with ultra vires acts have involved contracts made for unauthorized purposes. In some states, when a contract is entirely executor, either party can use a defense of ultra vires to prevent contract enforcement.

3. – PIERCING CORPORATE VEIL

Occasionally, the owners use a corporate entity to perpetrate a fraud, circumvent the law, or in some other way accomplish an illegitimate objective. In these situations, the court will ignore the corporate structure and pierce the corporate veil. The following are some of the
factors that frequently cause of the courts to pierce the corporate veil; 1) A party is tricked into a dealing.

2) The corporation is set up never to make a profit or always to be insolvent. Not enough money when it formed. 3) Statutory corporate formalities, such a holding required corporation meeting, are not allowed. 4) Personal and corporate interests are mixed together.

THE COMINGLING OF PERSONAL AND CORPORATE ASSETS
The potential for corporate assets to be used for personal benefit its especially great in a close corporation, in which the shares are held by a single person or by few individuals. In such a situation, the separate status of the corporate entity and the shareholder must be carefully preserved. Certain practices invite trouble “family owned corporation”, the comingling of corporate and personal funds, the failure to remit taxes, including payroll, and the shareholders continuous personal use of corporate property.

LOANS TO THE CORPORATION
Corporation laws usually do not specifically prohibit a shareholder from leading funds to her or his corporation. Any transaction has to be made in a good faith and for fair value.

4. – DIRECTORS, OFFICERS, AND SHAREHOLDERS

ROLE OF DIRECTORS
The board of directors is the ultimate authority in every corporation. Directors have responsibility for all policymaking decisions necessary to the management of all corporate affairs. Just as shareholders cannot act individually to bind the corporation, the directors must act as a body in carrying out routine corporate business. The board selects and removes the corporate officers.

Election of directors
Can be less than three, directors are elected by a majority vote of the
shareholders.

*Removal of directors
A director can be removed for cause (failing to perform).

*Vacancies on the board of directors
Can occur because of death or resignation or when a new position is created through amendment of the articles or bylaws.

Compensation of directors
Director usually are compensated for time, effort, etc. In many corporations directors are also chief corporate officers and receive compensation in their managerial positions.

Board of directors meetings
The board of directors conducts business by holding formal meetings with recorded minutes. The date of regular meetings are usually established in the articles or by board resolution.

Rights of directors
A corporate director must have rights to function properly in that position.

COMMITTEES OF THE BOARD OF DIRECTORS
1) Executive committee. The board members often elect an executive committee of directors to handle the interium management decisions between board of directors meetings. 2) Audit committee. Is responsible for the selection, compensation, and oversight of the independent public accountants who audit the corporations financial records. 3) Nominating committee. This one chooses the candidates for the board of directors that management wishes to submit to the shareholders in the next election. 4) Compensation committee. Reviews and decides the salaries, bonuses, stock options and other benefits. 5) Litigation committee. Decides whether the corporation should pursue requests by shareholders to file a lawsuit against some party that has allegedly harmed the corporation.

CORPORATE OFFICERS AND EXECUTIVES
Officers and other executives are hired by the board of directors.

DUTIES AND LIABILITIES OF DIRECTORS AND OFFICERS
Are deemed to be fiduciaries of the corporation because their relationship with the corporation and its shareholders is one of trust and confidence.

Duty of care
Directors and officers must exercise due care in performing their duties, they need to act in a good faith. If directors and officers failed to exercise due care results in harm to the corporation can be held liable for negligence.

*Duty to make informed and reasonable decisions
Directors and officers are expected to be informed on corporate matters and to conduct a reasonable investigations of this situations before making a decision.

*Duty to exercise reasonable supervision
Directors are also expected to exercise a reasonable amount of supervision when they delegate work to corporate officers and employees.

*Dissenting directors
Directors are also expected to attend board of directors meetings, and their votes should be entered into the minutes. Unless a dissent is entered in the minutes, the director is presumed to have assented. Dissenting directors are rarely held individually liable to the corporation.

*The business judgment rule
Directors and officers are expected to exercise due care and to use their best judgment in guiding corporate management, but they are not insurers of business success. Under the business judgment rule, a corporate director or officer will not be liable to the corporation or to its shareholders mistakes of judgment and bad business decisions.

Duty of loyalty
Defined as faithfulness to one’s obligations and duties. Typically involve; 1) Competing with the corporation.
2) Usurping a corporate opportunity
3) Having an interest that conflicts with the interest of the corporation. 4) Engaging in insider trading.
5) Authorizing a corporate transaction that is detrimental to minority shareholders. 6) Selling control over the corporation.

Conflicts of interest
Corporate directors often have many business affiliations, and a director may sit on the board of more than one corporation. Sometimes engage personal interest too.

Liability of directors and officers
Corporate directors and officers are personally liable for their own torts and crimes. Additionally they may be held personally liable for the torts and crimes committed by corporate personnel under their direct supervision.

THE ROLE OF SHAREHOLDERS
The acquisition of a share of stock makes a person an owner of and shareholder in a corporation, shareholders own the corporation but have no right to manage it. Basically the shareholders ownership control is limited to voting to elect or remove members of the board of directors and deciding whether to approve fundamental changes in the corporation. Shareholders are not agents of the corporation, nor do they have legal title to the corporations property, such as its building and equipment, they simply have an equitable (ownership) in the firm.

Shareholders powers
Shareholders must approve fundamental changes affecting the corporations before the changes can be implemented. Shareholder approval normally is required to amend the articles of incorporation or bylaws, to conduct a merger or dissolve the corporation, and to sell all or substantially all of the corporations assets. Shareholders have the power to vote to elect or
remove members of the board of directors.

Shareholders meetings
At least annually and proper notice need to be send it.

*Proxies
The law allows stockholders to either vote in person or appoint another person as their agent to vote their shares at the meetings. The signed appointment form authorizing an agent to vote the shares is called proxy.

Shareholder voting
Shareholders exercises ownership control through the power of their votes. Corporate business matters are presented in the form of resolutions, which shareholders vote to approve or disapprove.

*Quorum requirements
At least 50% need to be present. Extraordinary corporate matters, such as a merger, consolidation, or the dissolution of the corporation require approval by a higher percentage of representatives of all corporate shares entitled to vote.

*Voting list
The RMBCA requires a corporation to maintain an alphabetical voting list of shareholders.

*Cummulative voting
Most states permit and some require, shareholders to elect directors by cumulative voting, a voting method designed to allow minority shareholders to be represented on the board of directors.

*Other voting techniques
A voting trust is an agreement under which shareholder transfers the shares to a trustee, usually for a specified period of time. The trustee is responsible for voting the shares on behalf of the beneficiary-shareholder.

RIGHTS OF SHAREHOLDERS

Stock certificates
Is a certificate issued by a corporation that evidences ownership of a specified number of shares in the corporation. In jurisdiction that require the issuance of stock certificates, shareholders have the right to demand that the corporation issue certificates and record their names and addresses in the corporate stock record books.

Preemptive rights
With preemptive rights a shareholder receives a preference over all other purchasers to subscribe to or purchase a prorated share of a new issue of stock. Which means a shareholder who is given preemptive rights can purchase the same percentage of the new shares being issued as she or he already holds in the company. This rule does not apply to treasury shares, shares that are authorized but have not been issued.

Stock warrants
Are rights to buy stock at a stated price by a specified date that are given by the company.

Dividends
Is a distribution of corporate profits or income orders by the directors and paid to the shareholders in proportion to their respective shares in the corporation.

*Sources of funds for dividends
Depending on the state law, dividends may be paid from the following sources; 1) Retained earnings
2) Net profits
3) Surplus

*Directors failure to declare a dividend
Shareholders can ask the court to compel the directors to meet and declare a dividend. To succeed the shareholders must show that the directors have
acted so unreasonably in withholding the dividend that their conduct is an abuse of their discretion.

Inspection rights
Shareholders in a corporations enjoy both law and statutory inspection right (but limited). This include inspect voting lists, specified corporate records.

Transfer of shares
Corporate stock represents an ownership right in intangible personal property. The law generally recognizes the right of an owner to transfer property to another person unless there are valid restrictions on its transferability.

Rights on dissolution
When a corporation is dissolved and its outstanding debts and the claims of its creditors have been satisfied, the remaining assets are distributed on a pro rata basis among the shareholders.

The shareholders derivative suit
When the corporation is harmed by the actions of a third party, the directors can bring a lawsuit in the name of the corporation against that party.

LIABILITY OF SHAREHOLDERS
One of the hallmarks of the corporate organization is that shareholders are nor personally liable for the debts of the corporation. If the corporation fails the shareholder can lose their investment but that is the limit of their liability.

Watered stock
When a corporation issued shares for less than their fair market value, the shares are referred as watered stock. Usually the shareholder who receives the watered stock must to pay the difference to the corporation.

Duties of majority shareholders
A majority shareholder is regarded as having a fiduciary duty to the corporation and to the minority shareholders. This occurs when a single shareholder owns a sufficient number of shares to exercise de facto control over the corporation. In these cases the majority shareholders owe a fiduciary duty to the minority shareholders. A breach of fiduciary duties by those who control a closely held corporation normally constitutes what is known as oppressive conduct.

5. – MAJOR BUSINESS FORMS COMPARED