Chapter 39 - Corporate Formation & Financing

Factors that Lead Courts to Pierce the Corporate Veil

1. A party is tricked or mislead into dealing with the corporation rather than the individual. 2. The corporation is set up never to make a profit or always to be insolvent, or is too "thinly" capitalized--that is, it has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities. 3. The corporation is formed to evade an existing legal obligation. 4. Statutory corporate formalities, such as holding required corporation meetings, are not followed. 5. Personal and corporate interests are mixed together, or commingled, to the extent that the corporation has no separate identity.

In states where the courts will treat a corporation as a legal corporation despite the defect in formation, the following three requirements must be met:

1. A statute exists under which the corporation can be validly incorporated. 2. The parties have made a good faith attempt to comply with the statute. 3. The parties have undertaken to do business as a corporation.

Incorporation Procedures

1. Select state of incorporation (differing states offer different advantages in taxes or incorporating provisions) 2. Secure the corporate name (subject to state approval to ensure against duplication, must include corp., co., or ltd., and cannot infringe on another's trademark) 3. Prepare the articles of incorporation 4. file the articles of incorporation with the secretary of state

Requirements for S corporation status:

1. The corporation must be a domestic corporation. 2. The corporation must not be a member of an affiliated group of corporation. 3. The shareholders of the corporations must be individuals, estates, or certain trusts and tax-exempt organizations. 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 non-resident alien.

If a conflict arises among the various documents involving a corporation, the order of priority is as follows:

1. the US constitution 2. State constitution 3. State statutes 4. the articles of incorporation 5. Bylaws 6. Resolutions of the board of directors

Bylaws

After incorporation, the internal rules of management are adopted by the corporation at its first organizational meeting that must be held.

Retained Earnings

Corporate profits that are re-invested into the corporation thus will yield higher corporate profits in future and result in the company's stock to rise. Individual shareholders reap the benefits of these retained earnings in the capital gains that they receive when they sell their stock.

Non-profit Corporations

Corporations formed for purposes other than making a profit. Examples: Private hospitals, charities, religious organizations The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without exposing individual members to personal liability.

Private Corporations

Corporations that are created either wholly or in part for private benefit (profit). Most corporations are private.

The Alter-Ego Theory

Occurs when the courts pierce the corporate veil under the theory that the corporation was not operated as a separate entity, but was just another side of the individual or group who actually controlled the corporation. The theory is applied when a corporation is so dominated and controlled by an individual or group that the separate identities of the person and the corporation are no longer distinct. Courts use the alter-ego theory to avoid injustice or fraud that would result if the wrong does were allowed to hide behind the protection of limited liability.

Private Equity Capital

Private equity firms obtain their capital from wealthy investors in private markets. The firms use their private equity capital to invest in existing corporations. Usually, a private equity firm buys an entire corporation and may later reorganize it as a publicly held corporation.

Professional Corporations

Professionals such as physicians, lawyers, dentists, accountants can incorporate. Professional corporations are typically identified with the letters P.C. With the exception of malpractice, a shareholder in a professional corporation generally cannot be held liable for the torts committed by other professionals at the firm.

Improper Incorporation

The procedures for incorporation are very specific. If they are not followed precisely, others may be able to challenge the existence of the corporation.

The limited liability of Shareholders

This is the key advantage of the corporate form. Corporation shareholders are not personally liable for the obligations of the corporation beyond the extent of their investment.

Corporate Implied Powers

Unless prohibited by a constitution, statute, or articles of incorporation, a corporation has the implied power to perform all acts reasonably appropriate and necessary to accomplish its corporate purposes. Example: the corporation has the implied power to borrow funds within certain limit, lend funds, and extend credit to those with whom it has a legal or contractual relationship.

Corporate Taxation

Whether a corporation retains its profits or pays out dividends, those profits are subject to taxation by various levels of government. Double taxation-- the corporation pays tax on its profits and then if the profits are passed on to shareholders, the share holders must also pay income tax on them (unless dividends are a distribution of capital).

Ultra Vires Doctrine

"beyond the power" - acts of a corporation that are beyond its express or implied powers are ultra vires acts. Under Section 30 of the RCMBA, the shareholders can seek an injunction from a court to prevent the corporation from engaging in ultra vires acts. The attorney general can also obtain an injunction against the ultra vires transactions or to institute dissolution proceedings against the corporation. In the past, most ultra vires acts involve contracts for unauthorized purposes. However, most private corporations today operate for any legal purpose and so the ultra vires as declined. Cases that usually allege ultra vires involve nonprofit or municipal corporations.

Management of Closely Held Corporations

A closely held corporation has a single shareholder or a tightly knit group of shareholders, who usually hold the positions of directors and officers. Management closely resembles a partnership. To prevent a majority shareholder from dominating a closely held corporation, the company may require that more than a simple majority of the directors to approve any action taken by the board. This would apply to extraordinary actions.

Certificate of Authority

A corporation does not have the automatic right to conduct business in state other than the state it incorporates. A certificate of authority must be issued for to allow the corporation to exercise in that state all the powers conferred on it by its home state. If a corporation does not a certificate of authority, it is subject to substantial fines and sanctions.

Public Corporation

A corporation formed by the government to meet some political or governmental purpose.

Alien Corporation

A corporation formed in another country but doing business in the United States.

Foreign Corporation

A corporation formed in one state but doing business in another.

Domestic Corporation

A corporation is conducts business in the same state in which it incorporates.

Torts and Criminal Acts by a Corporation

A corporation is liable for torts committed by its agents or officers within the course and scope of their employment. The principle applies to a corporation exactly as it applies to the ordinary agency relationship. Under criminal law, a corporation may also be held liable for criminal acts of its agents and employees, provided the punishment is one that can be applied to a corporation--- fines.

Bond Indenture

A lending agreement that specifies the legal obligations on the part of the corporation, and the various features and terms of a particular bond issue.

Shareholder Agreement to Restrict Stock Transfers

A shareholder agreement can provide that when one of the original shareholders dies, his or her shares of stock in the corporation will be divided in such a way that the proportionate holdings of the survivors will be maintained. Agreements between shareholders can also restrict stock transfers in other ways.

S corporation treatment

A small domestic corporation (must have no more than 100 shareholders) that under Subchapter S of the IRS code, is given special tax treatment. S corporations allow shareholders to enjoy the limited liability of the corporate form but avoid the double-taxation feature. For tax purposes, an S corporation is treated differently than a regular corporation. An S corp is taxed like a partnership, so the corporate income passes through the shareholders, who pay personal taxes on it.

Dividends

Corporate profits that are distributed to shareholders.

Closely Held Corporations

Also known as privately held; it is a corporation whose shares are not publicly traded. In fact, there is no trading market for the shares. The shares are often held by family members or by a relatively small group of persons. Provisions in the RMBCA gives a closely held corporation considerable flexibility in its rules of operation. If all of the corporations shareholders agree in writing, the corporation can operate without directors, bylaws, annual or special shareholders' or directors' meetings, stock certificates, or formal records of shareholders' or directors' decisions.

Publicly Held Corporation

Any corporation whose shares are publicly traded in the securities market, such as the New York Stock Exchange or NASDAQ.

Potential Issues with Closely Held Corporation

Because the shares are held by a single person or a few individuals, usually family the potential for corporate assets to be used for personal benefit increases.

Promotional Activities

Businesspersons are personally liable for all pre-incorporation (before a corporation is even incorporated) contracts made with investors, accountants, and others on behalf of the future corporation. A provision in the contract to limit the promoter's (businessperson who is promoting the corporation prior to incorporation) liability in an initial contract with a third party should state that once the corporation is formed, the corporation assumes liability under the contract. If such a provision does not exist, then the promoter's personal liability continues.

Venture Capital

Capital provided to new business ventures by professional, outside investors (venture capitalists), usually groups of wealthy investors. Venture capital investments are high risk-- the investors must be willing to lose their invested funds--but offer the potential for well-above-average returns at some points in the future.

Piercing the Corporate Veil

Certain situations can impose liability on shareholders for the corporation's obligations.

If a corporation has substantially complied with all conditions precedent to incorporation is said to have ______ existence.

De jure Note: incorporators may fail to comply with all statutory mandates. If the defect is minor, like a wrong address, most courts will overlook the defect and find that corporation de defacto exists.

Bonds

Debt securities, represent the borrowing of funds by firms and governments.

Stocks

Equity securities, represent the purchase of ownership in the business firm.

Corporation by Estoppel

If a business holds itself out to others as being a corporation but has made no attempt to incorporate, the firm may be estopped from denying corporate status in a law suit by a third party.

Misappropriation of Closely Held Corporation Funds

If a majority shareholder takes advantage of his or her position and misappropriates company funds the normal remedy for the injured minority shareholders is to have their shares appraised and to be paid the fair market value for them.

Common Stock

Represents true ownership of a corporation. It provides a proportionate interest in the corporation with regard to: 1. control 2. earnings 3. net assets Includes voting rights -- 1 vote per share held. Voting rights in a corporation apply to the election of the firm's board of directors and to any proposed changes in the ownership structure of the firm. Has the lowest priority with respect to payment of dividends and distribution of assets on the corporation's dissolution.

Corporate Securities

Stocks and bonds

Transfer of shares in a closely held corporation

The closely held corporation could restrict transferability of shares to outside persons. Shareholders would be then required to offer their shares to the closely held corporation or the other shareholders before selling them to an outside purchaser.

Corporate Express Powers

The express powers are found in the articles of incorporation, in the state of incorporation, and in the state and federal constitutions.

Articles of Incorporation

The primary document needed to incorporate a business and is sent to the secretary of state. It must include: - the name of the corporation - the number of shares the corporation is authorized to issue - the name and street address of the corporation's initial registered agent and registered office. - the name of each incorporators Can include but not required: - duration and purpose (a corporation has perpetual existence unless stated otherwise) - internal management structure

Holding Company

a company whose business activity consists of holding shares in another company. Typically the holding company is established in a low-tax or no-tax offshore jurisdiction such as the Cayman Islands, Dubai, or Hong Kong. U.S. corporations sometimes set up a holding company in a low-tax offshore environment and then transfers its cash, bonds, stocks, and other investments to the holding company as a method of taxing their investments in the off-shore jurisdiction where the company is registered.

Preferred Stock

an equity security with preferences. Holders of preferred stock have priority over holders of common stock as to dividends and payment on the dissolution of the corporation. holders may or may not have voting rights.

Board of Directors

are entrusted with the responsibility for the overall management of the firm.

Corporate Officers

are hired by the board of directors to run the daily business operations of the corporation.

In states where the states' courts have interpreted the RMBCA as abolishing the common law doctrine of de facto corporations, the corporation __________ (does/does not) exist and the incorporators are _________ (not liable/personally liable).

does not; personally liable