Chapter 36 Corporate Formation and Financing

Redeemable Preferred Stock Redeemable preferred stock

(or callable preferred stock) permits a corporation to redeem (i.e., buy back) the preferred stock at some future date. The terms of the redemption are established when the shares are issued. Corporations usually redeem the shares when the current interest rate falls below the dividend rate of the preferred shares. Preferred stock that is not redeemable is called nonredeemable preferred stock. Nonredeemable stock is more common than redeemable stock.

Financing the Corporation: Equity Securities

A corporation needs to finance the operation of its business.

certificate of authority

A state can require a foreign corporation to qualify to conduct intrastate commerce within the state. Where a foreign corporation is required to qualify to conduct intrastate commerce in a state, it must obtain a from the state [RMBCA Section 15.01(a)].

incorporating a corporation

Corporations are creatures of statute. Thus, the organizers of a corporation must comply with the state's corporation code to form a corporation. The procedure for BLANKKK varies somewhat from state to state. The procedure for incorporating a corporation is discussed in the following paragraphs.

Types of Debt Instruments

Debt instruments are usually classified based on the length of the time of the instrument and whether the instrument is secured or not. Three classifications of debt securities are as follows:

novation

Even if the corporation agrees to be bound to the contract, the promoter remains liable on the contract unless the parties enter into a , a three-party agreement in which the corporation agrees to assume the contract liability of the promoter with the consent of the third party. After a novation, the corporation is solely liable on the promoter's contract.

Corporate Bylaws bylaws.

In addition to the articles of incorporation, corporations are governed by their Either the incorporators or the initial directors can adopt the bylaws of the corporation. The bylaws are much more detailed than are the articles of incorporation.

Corporate Seal

Most corporations adopt a [RMBCA Section 3.02(2)]. Generally, the seal is a design that contains the name of the corporation and the date of incorporation.

Registered Agent

The registered agent is empowered to accept service of process on behalf of the corporation.

Par Value and No Par Value Shares Common shares

are sometimes categorized as either par or no par. Par value shares are common stock on which the corporation has set the lowest price at which the shares may be issued by the corporation. It does not affect the market value of the shares. Most shares that are issued by corporations are no par value shares. No par value shares are not assigned a par value. The RMBCA has eliminated the concept of par value.

Publicly held corporations are for-profit

corporations that have many shareholders. Often, they are large corporations with hundreds or thousands of shareholders, and their shares are usually traded on organized securities markets.

Bond. A bond is a long-term

debt security that is secured by some form of collateral (e.g., real estate, personal property). Thus, bonds are the same as debentures except that they are secured. Secured bondholders can foreclose on the collateral in the event of nonpayment of interest, principal, or other specified events.

The dissolution of a corporation

does not impair any rights or remedies available against the corporation or its directors, officers, or shareholders for any right or claim existing or incurred prior to dissolution.

Selecting a State for Incorporating a Corporation

A corporation can be incorporated in only one state, even though it can do business in all other states in which it qualifies to do business. In choosing a state for incorporation, the incorporators, directors, and/or shareholders must consider the corporation law of the states under consideration.

Corporate Powers

A corporation has the same basic rights to perform acts and enter into contracts as a physical person [RMBCA Section 3.02].

domestic corporation

A corporation is a in the state in which it is incorporated.

Purpose of a Corporation

Example A limited-purpose clause could state that a corporation may only engage in the business of real estate development.

Articles of Incorporation

The articles of incorporation may also include provisions concerning (1) the period of duration (which may be perpetual), (2) the purpose or purposes for which the corporation is organized, (3) limitation or regulation of the powers of the corporation, (4) regulation of the affairs of the corporation, or (5) any provision that would otherwise be contained in the corporation's bylaws. Today, corporations most often provide their articles of incorporation online.

A promoter

is a person who organizes and starts a corporation, finds the initial investors to finance the corporation, and so on.

Publicly held corporations are for-profit

Examples Google, Inc.; Facebook, Inc.; eBay, Inc.; Starbucks Corporation; Apple Computer, Inc.; The Proctor & Gamble Company; Wal-Mart Stores, Inc.; Ford Motor Company; and Yahoo!, Inc., are examples of publicly held corporations.

Ultra Vires Act

Examples of ultra vires acts would be where the corporation makes loans to officers or directors when such an act is prohibited by law or if the corporation makes excessive contributions to charities or political campaigns.

Selecting a State for Incorporating a Corporation

For the sake of convenience, most corporations (particularly small ones) choose the state in which the corporation will be doing most of its business as the state for incorporation. Large corporations generally opt to incorporate in the state with the laws that are most favorable to the corporation's internal operations (e.g., Delaware).

Corporate Seal

It is imprinted by the corporate secretary on certain legal documents (e.g., real estate deeds) that are signed by corporate officers or directors. The seal is usually affixed using a metal stamp. The following feature discusses an election that can be made regarding federal tax obligations.

Common Stock

Persons who own common stock are called common stockholders. are issued common stock certificates to show evidence of their ownership interest in the corporation. However, electronic registration of common stockholder ownership interests is supplanting paper stock certificates. Corporations are no longer required by law to issue paper certificates, and many do not.

Authorized, Issued, and Outstanding Shares

The number of shares provided for in the articles of incorporation is called authorized shares [RMBCA Section 6.01]. The shareholders may vote to amend the articles of incorporation to increase this amount. Authorized shares that have been sold by the corporation are called issued shares. Not all authorized shares have to be issued at the same time. Authorized shares that have not been issued are called unissued shares. The board of directors can vote to issue unissued shares at any time without shareholder approval.

incorporators

The parties who sign the articles of incorporation are called BLANKKK [RMBCA Section 2.01]. Promoters and BLANKKK often become shareholders, directors, or officers of the corporation.

Private corporations are formed to conduct privately owned business.

They are owned by private parties, not by the government. They range from small one-owner corporations to large multinational corporations such as Microsoft Corporation.

certificate of authority

This requires the foreign corporation to file certain information with the secretary of state, pay the required fees, and appoint a registered agent for service of process. Conducting intrastate business in a state in which it is not qualified subjects a corporation to fines and other penalties [RMBCA Section 15.02].

Owners of corporations are called shareholders. Shareholders

are owners of a corporation who elect the board of directors and vote on fundamental changes in the corporation.

A corporation's express powers are found in

(1) the U.S. Constitution, (2) state constitutions, (3) federal statutes and state statutes, (4) federal and state administrative agency rules, (5) articles of incorporation, (6) bylaws, and (7) resolutions of the board of directors. Corporation codes normally state the express powers granted to the corporation.

Profit corporations, or for-profit corporations

, are private corporations that are created to conduct a business for profit and can distribute profits to shareholders in the form of dividends.

Common Stock

Common stockholders have the right to elect directors and to vote on mergers and other important matters.

foreign corporation

It is a in all other states and jurisdictions.

municipal corporations.

Local government corporations are often called

Professional corporations

are private corporations formed by professionals such as lawyers, accountants, physicians, and dentists. The abbreviations P.C. (professional corporation), P.A. (professional association), and S.C. (service corporation) often identify professional corporations.

Not-for-profit corporations, or nonprofit corporations,

are private corporations that are formed for charitable, educational, religious, or scientific purposes. Although not-for-profit corporations may make a profit, they are prohibited by law from distributing this profit to their members, directors, or officers. States have statutes that govern the formation, operation, and dissolution of nonprofit corporations.

Corporations

are the most dominant form of business organization in the United States, generating more than 85 percent of the country's gross business receipts. Corporations range in size from one owner to thousands of owners.

Corporate Status

The RMBCA provides that corporate existence begins when the articles of incorporation are filed. The secretary of state's filing of the articles of incorporation is conclusive proof that the corporation satisfied all conditions of incorporation. After that, only the state can bring a proceeding to cancel or revoke the incorporation or involuntarily dissolve the corporation. Third parties cannot thereafter challenge the existence of the corporation or assert its lack of existence as a corporation as a defense against the corporation [RMBCA Section 2.03]. The corollary to this rule is that failure to file articles of incorporation is conclusive proof of the nonexistence of a corporation.

equity securities and debt securities

The most common way to do this is by selling . Equity securities (or stocks) represent ownership rights in the corporation.

receive dividends

In return for their investment, common stockholders declared by the board of directors.

Authorized, Issued, and Outstanding Shares

A common and preferred stockholder's investment in a corporation has traditionally been represented by a stock certificate printed on paper. Many certificates had beautiful designs. However, paper certificates are becoming a thing of the past as corporations switch to recording shareholders' ownership interests electronically.

Purpose of a Corporation

A corporation can be formed for any lawful purpose. Many corporations include a general-purpose clause in their articles of incorporation. Such a clause allows the corporation to engage in any activity permitted by law. The majority of articles of incorporation include a general-purpose clause.

Judicial dissolution.

A corporation can be involuntarily dissolved by a judicial proceeding. Judicial dissolution can be instituted by the attorney general of the state of incorporation if the corporation (1) procured its articles of incorporation through fraud or (2) exceeded or abused the authority conferred on it by law [RMBCA Section 14.30(1)]. If a court dissolves a corporation, the court enters a decree of dissolution that specifies the date of dissolution [RMBCA Section 14.33].

Voluntary dissolution.

A corporation can be voluntarily dissolved. If the corporation has not commenced business or issued any shares, it may be dissolved by a vote of the majority of the incorporators or initial directors [RMBCA Section 14.01]. After that, the corporation can be voluntarily dissolved if the board of directors recommends dissolution and a majority of shares entitled to vote (or a greater number, if required by the articles of incorporation or bylaws) votes for dissolution as well [RMBCA Section 14.02]. For a voluntary dissolution to be effective, articles of dissolution must be filed with the secretary of state of the state of incorporation. A corporation is dissolved on the effective date of the articles of dissolution [RMBCA Section 14.03].

Authorized, Issued, and Outstanding Shares

A corporation is permitted to repurchase its shares [RMBCA Section 6.31]. Repurchased shares are commonly called treasury shares. Treasury shares cannot be voted by the corporation, and dividends are not paid on these shares. Treasury shares can be reissued by the corporation. The shares that are in shareholder hands, whether originally issued or reissued treasury shares, are called outstanding shares. Only outstanding shares have the right to vote [RMBCA Section 6.03].

Purpose of a Corporation

A corporation may choose to limit its purpose or purposes by including a limited-purpose clause in the articles of incorporation [RMBCA Section 3.01]. Such a clause stipulates the specific purposes and activities that the corporation can engage in. The corporation can engage in no other purposes or activities.

Centralized management.

A corporation usually has a centralized management composed of the board of directors and officers of the corporation. The board of directors makes policy decisions concerning the operation of a corporation. The members of the board of directors are elected by the shareholders. The directors, in turn, appoint corporate officers to run the corporation's day-to-day operations. Together, the directors and officers form the corporate management.

amendment with the secretary of state of the incorporation

A corporation's articles of incorporation can be amended to contain any provision that could have been lawfully included in the original document [RMBCA Section 10.01]. An amendment must show that (1) the board of directors adopted a resolution recommending the amendment and (2) the shareholders voted to approve the amendment [RMBCA Section 10.03]. The board of directors of a corporation may approve an amendment to the articles of incorporation without shareholder approval if the amendment does not affect rights attached to shares [RMBCA Section 10.02]. After the amendment has been approved, the corporation must file articles of BLANKKK [RMBCA Section 10.06].

Ultra Vires Act

An act by a corporation that is beyond its express or implied powers is called an If an ultra vires act occurs, shareholders can sue for an injunction to prevent the corporation from engaging in the act and sue the officers or directors who caused the act for damages. The attorney general of the state of incorporation can bring an action to enjoin an ultra vires act or to dissolve the corporation if the act is illegal [RMBCA Section 3.04].

Limited Liability of Shareholders

As separate legal entities, corporations are liable for their own debts and obligations.

When starting a new corporation, the organizers must choose a name for the entity. To ensure that the name selected is not already being used by another business, the organizers should do the following [RMBCA Section 4.01]:

Choose a name (and alternative names) for the corporation. The name must contain the word corporation, company, incorporated, or limited or an abbreviation of one of these words (i.e., Corp., Co., Inc., Ltd.). Make sure the name chosen does not contain any word or phrase that indicates or implies that the corporation is organized for any purpose other than those stated in the articles of incorporation. For example, a corporate name cannot contain the word Bank if it is not authorized to conduct the business of banking. Determine whether the name selected is federally trademarked by another company and is therefore unavailable for use. Trademark lawyers and specialized firms can conduct trademark searches for a fee. Determine whether the chosen name is similar to other nontrademarked names and is therefore unavailable for use. Lawyers and specialized firms can conduct such searches for a fee. Determine whether the name selected is available as a domain name on the Internet. If the domain name is already owned by another person or business, the new corporation cannot use this domain name to conduct e-commerce over the Internet. Therefore, it may be advisable to select another corporate name.

Free transferability of shares.

Corporate shares are by a shareholder by sale, assignment, pledge, or gift unless they are issued pursuant to certain exemptions from securities registration. Shareholders may agree among themselves as to restrictions on the transfer of shares. National securities markets, such as the New York Stock Exchange and NASDAQ, have been developed for the organized sale of securities.

corporation codes

Corporations can be created only pursuant to the laws of the state of incorporation. These laws—commonly referred to as —regulate the formation, operation, and dissolution of corporations. The state legislature may amend its corporate statutes at any time. Such changes may require a corporation's articles of incorporation to be amended.

Perpetual existence.

Corporations unless a specific duration is stated in a corporation's articles of incorporation. The existence of a corporation may be voluntarily terminated by the shareholders. The death, insanity, or bankruptcy of a shareholder, a director, or an officer of a corporation does not affect its existence.

Registered Agent

Example If someone is suing a corporation, the complaint and summons are served on the registered agent. If no registered agent is named or the registered agent cannot be found at the registered office with reasonable diligence, service may be made by mail or alternative means [RMBCA Section 5.04]. The following feature discusses an election that can be made when forming a corporation.

Limited Liability of Shareholders

Example Tina, Vivi, and Qixia form IT.com, Inc., a corporation, and each contributes $100,000 capital. The corporation borrows $1 million from State Bank. One year later, IT.com, Inc., goes bankrupt and defaults on the $1 million loan owed to State Bank. At that time, IT.com, Inc.'s, only asset is $50,000 cash, which State Bank recovers. Tina, Vivi, and Qixia each lose their $100,000 capital contribution, which IT.com, Inc., has spent. However, Tina, Vivi, and Qixia are not personally liable for the $950,000 still owed to State Bank. State Bank must absorb this loss.

Organizational Meeting of the Board of Directors

Examples Actions taken at the meeting may include accepting share subscriptions, approving the form of the stock certificate, authorizing the issuance of the shares, ratifying or adopting promoters' contracts, authorizing the reimbursement of promoters' expenses, selecting a bank, choosing an auditor, forming committees of the board of directors, fixing the salaries of officers, hiring employees, authorizing the filing of applications for government licenses to transact the business of the corporation, and empowering corporate officers to enter into contracts on behalf of the corporation. Exhibit 36.4 contains sample corporate resolutions from an organizational meeting of a corporation.

Corporate Bylaws

Examples Bylaws typically specify the time and place of the annual shareholders' meeting, how special meetings of shareholders are called, the time and place of annual and monthly meetings of the board of directors, how special meetings of the board of directors are called, the notice required for meetings, the quorum necessary to hold a shareholders' or board meeting, the required vote necessary to enact a corporate matter, the corporate officers and their duties, the committees of the board of directors and their duties, where the records of the corporation are kept, directors' and shareholders' rights to inspect corporate records, the procedure for transferring shares of the corporation, and so on. Sample provisions of corporate by laws are set forth in Exhibit 36.3.

limited liability.

Generally, the shareholders have only The of shareholders means that they are liable only to the extent of their capital contributions and do not have personal liability for the corporation's debts and obligations (see Exhibit 36.1).

Promoters' liability and the corporation's liability on promoters' contracts follow these rules:

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.

Dissolution and Termination of Corporations 5. Describe the importance of Delaware corporation law.

In some situations, a corporation will stop doing business and cease operations and will no longer be in business. This could happen for many reasons, such as failure of the business, a shareholder is retiring, the company has declared liquidation bankruptcy, or if certain legal requirements are not met and the government orders the corporation to cease doing business. This is called the dissolution of the corporation.

general corporation statutes

States have enacted BLANKKK that permitted corporations to be formed without the separate approval of the legislature. Today, most corporations are formed pursuant to general corporation laws of the states. The formation and financing of corporations are discussed in this chapter.

Common stockholders

That is, creditors and preferred shareholders must receive their required interest and dividend payments before common shareholders receive anything. Common stock does not have a fixed maturity date.

Authorized, Issued, and Outstanding Shares

The RMBCA allows shares to be issued in exchange for any benefit to the corporation, including cash, tangible property, intangible property, promissory notes, services performed, contracts for services performed, or other securities of the corporation. In the absence of fraud, the judgment of the board of directors or shareholders as to the value of consideration received for shares is conclusive [RMBCA Sections 6.21(b), 6.21(c)].

Registered Agent

The articles of incorporation must identify a registered office with a designated registered agent (either an individual or a corporation) in the state of incorporation [RMBCA Section 5.01]. The registered office does not have to be the same as the corporation's place of business. A statement of change must be filed with the secretary of state of the state of incorporation if either the registered office or the registered agent is changed. Attorneys often act as the registered agents of corporations.

Corporate Bylaws

The board of directors has the authority to amend the bylaws unless the articles of incorporation reserve that right for the shareholders. The shareholders of the corporation have the absolute right to amend the bylaws even though the board of directors may also amend the bylaws [RMBCA Section 10.20].

Government-owned corporations (or public corporations) example

The federal government charters and owns a number of corporations, including the Corporation for Public Broadcasting (CPB), the Federal Deposit Insurance Corporation (FDIC), and the Tennessee Valley Authority (TVA).

Articles of Incorporation

The name of the corporation. The number of shares the corporation is authorized to issue. The address of the corporation's initial registered office and the name of the initial registered agent. The name and address of each incorporator.

Administrative dissolution.

The secretary of state can obtain administrative dissolution of a corporation if (1) it failed to file an annual report, (2) it failed for 60 days to maintain a registered agent in the state, (3) it failed for 60 days after a change of its registered agent to file a statement of such change with the secretary of state, (4) it did not pay its franchise fee, or (5) the period of duration stated in the corporation's articles of incorporation has expired [RMBCA Section 14.20]. If the corporation does not cure the default within 60 days of being notified of it, the secretary of state issues a certificate of dissolution that dissolves the corporation [RMBCA Section 14.21].

Indenture Agreement

The terms of a debt security are commonly contained in a contract between the corporation and the holder; this contract is known as an indenture agreement (or simply an indenture). The indenture generally contains the maturity date of the debt security, the required interest payment, the collateral (if any), rights to conversion into common or preferred stock, call provisions, any restrictions on the corporation's right to incur other indebtedness, the rights of holders on default, and so on. It also establishes the rights and duties of the indenture trustee. Generally, a trustee is appointed to represent the interest of the debt security holders. Bank trust departments often serve in this capacity. The following feature discusses why the state of Delaware attracts corporate formations.

Government-owned corporations (or public corporations)

are formed by government entities to meet a specific governmental or political purpose. Many public corporations are formed pursuant to state law. Most cities and towns are formed as corporations, as are most water, school, sewage, and park districts.

Winding Up, Liquidation,

and Termination A dissolved corporation continues its corporate existence but may not carry on any business except as required to wind up and liquidate its business and affairs [RMBCA Section 14.05]. In a voluntary dissolution, the liquidation is usually carried out by the board of directors. If the dissolution is involuntary or the dissolution is voluntary but the directors refuse to carry out the liquidation, a court-appointed receiver carries out the winding up and liquidation of the corporation [RMBCA Section 14.32].

Implied powers allow

a corporation to exceed its express powers in order to accomplish its corporate purpose. For example, a corporation has implied power to open a bank account, reimburse its employees for expenses, purchase insurance, and the like.

equity securities and debt securities

can be common stock and preferred stock. These are discussed in the following paragraphs.

Common stock

is an equity security that represents the residual value of a corporation. Common stock has no preferences. If a corporation is liquidated, the creditors and preferred shareholders are paid the value of their interests first, and the common shareholders are paid the value of their interests (if any) last. Corporations may issue different classes of common stock [RMBCA Sections 6.01(a), 6.01(b)].

Note. A note is a short-term

debt security with a maturity of five years or less. Notes can be either unsecured or secured. They usually do not contain a conversion feature. They are sometimes made redeemable.

The Corporation as a Legal "Person" A corporation is a separate legal entity (or legal person)

for most purposes. Corporations are treated, in effect, as artificial persons created by the state that can sue or be sued in their own names, enter into and enforce contracts, hold title to and transfer property, and be found civilly and criminally liable for violations of law. Because corporations cannot be put in prison, the normal criminal penalty is the assessment of a fine, loss of a license, or another sanction.

The Committee on Corporate Laws of the American Bar Association first drafted the Model Business Corporation Act (MBCA)

in 1950. The model act was intended to provide a uniform law regulating the formation, operation, and termination of corporations. In 1984, the committee completely revised the MBCA and issued the . Certain provisions of the RMBCA have been amended since 1984. Most states have adopted all or part of the RMBCA. The RMBCA serves as the basis for the discussion of corporation law in this text. There is no general federal corporation law governing the formation and operation of private corporations.

Debenture. A debenture

is a long-term (often 30 years or more), unsecured debt instrument that is based on a corporation's general credit standing. If the corporation encounters financial difficulty, unsecured debenture holders are treated as general creditors of the corporation (i.e., they are paid only after the secured creditors' claims are paid).

The articles of incorporation (or corporate charter)

is the basic governing document of a corporation. It must be drafted and filed with and approved by the state before the corporation can be officially incorporated. Under the RMBCA, the articles of incorporation must include the following [RMBCA Section 2.02(a)]:

Bylaws

may contain any provisions for managing the business and affairs of the corporation that are not inconsistent with law or the articles of incorporation [RMBCA Section 2.06]. They do not have to be filed with any government official. Today, corporations most often provide their online. The are binding on the directors, officers, and shareholders of the corporation. The govern the internal management structure of a corporation.

Organizational Meeting of the Board of Directors

of the initial directors of a corporation must be held after the articles of incorporation are filed. At this meeting, the directors must adopt the bylaws, elect corporate officers, and transact such other business as may come before the meeting [RMBCA Section 2.05].

A closely held corporation, or privately held corporation,

on the other hand, is a private for-profit corporation whose shares are usually owned by a few shareholders, who are often family members, relatives, or friends. However, some privately held companies are large in size, such as S. C. Johnson & Son, Inc. (often referred to as "S. C. Johnson, A Family Company"), which is a global company with more than 10,000 employees.

Termination occurs

only after the winding up of the corporation's affairs, the liquidation of its assets, and the distribution of the proceeds to the claimants. The liquidated assets are paid to claimants according to the following priority: (1) expenses of liquidation and creditors according to their respective liens and contract rights, (2) preferred shareholders according to their liquidation preferences and contract rights, and (3) common stockholders.

Promoters

sometimes enter into contracts on behalf of a corporation prior to its actual incorporation. Promoters' contracts include leases, sales contracts, contracts to purchase real or personal property, employment contracts, and the like.