Ch. 39: Corporation Formation

Ultra Vires Acts trigger the following remedies, 3 actions you can take:

Derivative Action Direct action state action

State of Incorporation

Delaware is a popular choice because of its corporate laws; although firms are increasingly incorporating where they plan to base their operations.

The express powers of a corporation are found in the following sources, and any conflict between sources is to be resolved according to the following priorities

(1) The United States Constitution takes priority over (2) State Constitutions, which take priority over (3) State Statutes, which take priority over (4) Articles of Incorporation the corporation filed in the state of incorporation, containing information about the corporation's organization and functions, which take priority over (5) Corporate By-Laws the corporation's shareholders adopt, which take priority over (6) Resolutions - i.e., policy statements - the corporation's board of directors periodically adopts.

De facto status requires:

(1) a state statute under which the corporation can be validly incorporated; (2) a good faith effort by the corporation to comply with that statute; and (3) the corporation has actually undertaken to do business.

In order to qualify as an S Corporation, the corporation:

(1) must be incorporated in the U.S., (2) must not be a member of an affiliated group of corporations, (3) must be owned by individuals, estates, or certain trusts (other corporations, partnerships, or nonqualifying trusts cannot own S Corporation shares), (4) must have 100 or fewer shareholders, (5) must have only one class of stock (although not all shares must have the same voting rights), and (6) must not have any nonresident alien shareholders.

The corporate entity's key legal components are its

(1) shareholders, who own a share of the corporation proportional to their ownership of the corporation's outstanding stock; (2) directors, who the shareholders elect to oversee the corporation's affairs and to be responsible for corporate policy; and (3) officers, who the directors hire to be responsible for running the corporation's day-to-day operations.

A court may pierce the corporate veil if

(1) the plaintiff was tricked or misled into dealing with the corporation rather than the individual; (2) the corporation was created never to make a profit or to evade an existing legal obligation; (3) the corporation had insufficient capital when formed to meet its prospective debts or potential liabilities; (4) the corporation does not observe statutorily-required corporate formalities; or (5) personal and corporate interests are so commingled, or corporate decisionmaking is so dominated by an individual or small group, that the corporation ceases to have a separate identity from, and becomes the alter ego of, its owners or the dominant individual or group.

Corporation by Estoppel

A business entity that holds itself out as a corporation will normally be estopped from denying corporate status against claims by a third party.

S Corporation

A closely-held corporation that is taxed like a partnership, while affording its owners the limited liability of a corporation.

Holding Company

A company, established in a low-tax or no-tax offshore jurisdiction, to which a corporation transfers its cash, stocks, bonds, and other investments to reduce its domestic tax liability.

Public Corporation

A corporation a government forms to serve some public purpose. ♣ Amtrack, us postal service - public - us gov

Alien Corporation

A corporation doing business in a given state, but incorporated in a foreign country (or otherwise formed, as provided for by the laws thereof). ♣ Alien - outside of the country, incorporated outside of the u.s. and doing business with US

Foreign Corporation

A corporation doing business in a given state, but incorporated in another state.

Private Corporation

A corporation formed by and owned by individuals and other private interests. Can be : publicly-held, or privately-held

Domestic Corporation

A corporation incorporated in a given state and doing business in that same state. ♣ Domestic - state law to form, incorporate in a specific state (most in Delaware because less taxes), where you're incorporated • 1st to incorporate outside of Delaware - NIKE (incorp in Oregon) ♣ Why does this matter?

Corporate Constitutional Rights

A corporation is a "person" for purposes of most Constitutional rights (e.g., freedom of speech, protection against double jeopardy, due process); however, corporations do not enjoy the Fifth Amendment protection against self-incrimination or the protection of the Privileges and Immunities Clause. CANNOT PLEAD THE 5TH o Are people, like LLCs o Have constitutional rights, but they're a little more limited o Cannot plead the 5th ♣ Express what they're doing through business records ♣ Can't really talk ♣ Can't "remain silent" ♣ Do have constitutuional rights, some are more limited to protect the general public

Tort Liability

A corporation is liable, under the doctrine of respondeat superior, for the torts its agents or employees commit within the course and scope of their duties. ♣ have safety things in place and insurance coverage because responsible for what agents do

Criminal Liability

A corporation may be liable for its agents' or employees' criminal acts, as long as the criminal sanctions can be applied to the corporation (e.g., fines). knew or should've known test - criminal liable (SOX has increased this)

Non-Profit Corporation

A corporation typically formed for charitable, educational, religious, or similar purposes, and organized and operated without the goal of making a profit. o Not-for-profit (501 c3) ♣ No shareholders ♣ Do make a profit - no one to distribute it to ♣ If you're going to donate money to a charitable fund - want to look at where you're money is going ♣ Have to be careful, more bookkeeping involved than in an actual corporation ♣ Churches - catholic church owns a lot of property and is exempt from property taxes ♣ Friend got together a cleaning crew to help after katrina - Getting all these contributions • Had to apply for 501c3

De Facto Corporation

A corporation which, despite some substantive defect in its incorporation or continuing status, is recognized to exist, even if its existence is improper or illegal. o Defacto - more of a defect (leave out one document altogether and don't get lawyer) ♣ Even if there's a substantial defect court can come back and say we will treat you as a corp ♣ If there is a problem - will look to fact and circumstances and maybe give you benefit of the doubt

De Jure Corporation

A corporation whose articles, while containing some technical defect, substantially comply with the laws of the state of incorporation.

Privately-Held Corporation

A corporation whose shares are not publicly-traded, and may generally only be bought from or sold to the corporation. ♣ Privately held, publically traded - private

Publicly-Held Corporation

A corporation whose shares are sold to and held by, or on behalf of, the general public, and are traded on a public exchange.

Corporation

A legal entity formed according to the statutory requirements of its state of incorporation.

Closely-held Corporation (a.k.a. "close corporation")

A privately-held corporation with a small number of shareholders, often members of the same family (can generally restrict transfer of its stock). o Small family business (doesn't have to be that small) o Rules usually more relaxed o Have to have shareholder meetings, investor meetings, o Have to a separate personal and corp account o Right of first refusal (should have it in there) ♣ Lot of transfer restrictions ♣ Treated more like an llc ♣ Lot of flexibility, less violence o Treated more like an LLC - don't have all the formalities you have with a regular corporation

Ultra Vires Acts

Acts of a corporation - through one or more officers or directors - that exceed the corporation's express and implied powers, o bad, an ultra vires act is n act that a director, employee does outside the scope of their authority ♣ Acts will definitely lead to piercing the corporate veil

Corp doing business in several jurisdictions

Any particular corporation doing business in several jurisdictions can be a domestic corporation in one jurisdiction, and a foreign corporation in another. The distinction depends on in which jurisdiction the corporation's activity is being assessed.

Implied Powers of corporations

Barring express constitutional, statutory, or charter prohibitions, a corporation has the implied power to perform all acts reasonably appropriate and necessary to accomplish its corporate purpose.

Transfer Restrictions of closely-helds

Because transferring shares to a non-shareholder can fundamentally alter a closely-held corporation's nature, closely-held corporation articles of incorporation, shareholder agreements, or both, often require a shareholder who wishes to exit the corporation to sell their shares to the other existing shareholders, or at least offer the other existing shareholders or the corporation a right of first refusal.

citizens united case

Citizens United sought an injunction against the Federal Election Commission in the United States District Court for the District of Columbia to prevent the application of the Bipartisan Campaign Reform Act (BCRA) to its film Hillary: The Movie. The Movie expressed opinions about whether Senator Hillary Rodham Clinton would make a good president. In an attempt to regulate "big money" campaign contributions, the BCRA applies a variety of restrictions to "electioneering communications." Section 203 of the BCRA prevents corporations or labor unions from funding such communication from their general treasuries. Sections 201 and 311 require the disclosure of donors to such communication and a disclaimer when the communication is not authorized by the candidate it intends to support. Citizens United argued that: 1) Section 203 violates the First Amendment on its face and when applied to The Movie and its related advertisements, and that 2) Sections 201 and 203 are also unconstitutional as applied to the circumstances. The United States District Court denied the injunction. Section 203 on its face was not unconstitutional because the Supreme Court in McConnell v. FEC had already reached that determination. The District Court also held that The Movie was the functional equivalent of express advocacy, as it attempted to inform voters that Senator Clinton was unfit for office, and thus Section 203 was not unconstitutionally applied. Lastly, it held that Sections 201 and 203 were not unconstitutional as applied to the The Movie or its advertisements. The court reasoned that the McConnell decision recognized that disclosure of donors "might be unconstitutional if it imposed an unconstitutional burden on the freedom to associate in support of a particular cause," but those circumstances did not exist in Citizen United's claim.

Corporate Taxation

Corporate profits are taxable to the corporation when they are distributed in the form of dividends, but not when they are "reinvested" in the corporation as retained earnings. ♣ Taxed twice ♣ Retained earnings - taxed once at corp rate ♣ Dividends - taxed twice

Dividends

Corporate profits distributed to shareholders in proportion to their shares held.

Retained Earnings

Corporate profits not distributed to shareholders.

Foreign and alien corps business rights outside of state of incorporation

Foreign and alien corporations do not automatically have the right to do business in a state other than the one in which they are incorporated. They may be required to obtain a certificate of authority from any other state in which they want to do business. once corp gets - can generally exercise in that state all the powers conferred by it in its home state if don't get and do business in that state - state can impose substantial fines and sanctions on that corp.

Appraisal Rights of closely-helds

If a majority shareholder misappropriates corporate funds or opportunities, minority shareholders are entitled to be paid the appraised fair market value of their shares.

Corp veil protects it from personal liability. How can owners and officers pierce the corp veil?

If the owners or officers or directors of a corporation use a corporate entity to commit fraud or act illegally, a plaintiff may be able to "pierce the corporate veil" - i.e., disregard the corporate entity and its attendant limitations on personal liability - and sue the wrongdoers individually for actions they took as owners, officers, or directors of the corporation.

Certificate of Incorporation

Once the articles have been executed by the incorporators, they are sent to the appropriate state official, along with a filing fee, in return for which the state of incorporation may issue a certificate of incorporation evidencing the corporation's legal existence.

Direct Action

The corporation may, itself, sue the officers or directors to recover damages caused by a completed ultra vires act. sue the actual person who is mebehaving

Corporate Name name must include

The corporation's proposed name must indicate its corporate status - by including a word like Corporation (Corp.), Incorporated (Inc.), etc. - and be neither the same as, nor deceptively similar to, that of an existing corporation in the state of incorporation. A corporation planning to do business in other states should check the proposed name's availability in those states. choice of name subject to state approval to preserve against duplication or deception (some state statutes require the secretary of state to run a check on the proposed name in the state of incorp.) once cleared a name can be reserved for a short time (for a fee) pending the completion of the articles of incorp. (corp., inc., co., ltd. - limited) if comp. already in state named Star inc., and want to name your comp. Star co. - state will not allow b/c "deceptively similar" to an existing name in the state of incorp

Derivative Action

The corporation's shareholders may sue on behalf of the corporation (1) to enjoin the ultra vires act before the officers or directors commit it or (2) to recover damages caused by a completed ultra vires act. • derivative action - if shareholders have to do it o entire board misbehaving (not doing their job), board can't sue themselves, shareholders have to come in and do it o where are we going to find out where the other shareholders are? o Partners or members have right to inspect the books at all times, shareholders can, but have to give notice and good reason - corp's don't want this to happen - cannot say I think they're doing something wrong o When you plead/allege fraud; you must plead it with particularity - something specific ♣ How will you get this from corp? o Not as easy as it sounds

Articles of Incorporation

The primary document needed to incorporate, the articles should include, at a minimum, the corporate name, the number of authorized shares, and the names and addresses of its registered agent and its incorporators, and provide authority for its future business organization and operations. (See Exhibit 39-1) o Have to file o Basic rules o This is what our business is o Talk about directors o Where you identify your agent for service of process**** o Initial filing - keep general

State Action

The state attorney general may seek an injunction or may dissolve the corporation. • state action - if somebody is committing a crime the state will come in and they will file some sort of suit (criminal maybe civil to follow), board has to do this o someone misbehaves? Board should fire and sue; if whole board then the shareholders should step in

501c3

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Organizations described in section 501(c)(3) are commonly referred to as charitable organizations. Organizations described in section 501(c)(3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions in accordance with Code section 170.

How does a closely-held corp protect itself against majority shareholder domination?

To protect against majority shareholder domination, a closely-held corporation's articles of incorporation may require more than simple majority approval of any board action.

if CEO "personally guarantees it"

ask for it in writing Anyone who says this - get it in writing

IMPROPER INCORPORATION

de jure corp de facto corp corp by estoppel dejure and effective (don't have to know to distinguish between the 2 for test)

A shareholder's personal liability for the corporation's obligations

is generally limited to the value of her investment in the corporation's stock.

Incorporating under state law

o Decide which state you'll be in o Business locally or nationwide? ♣ Make sure name can be used in business in another area if nationwide, or may want to change name o Can reserve a name so no one else can use it ♣ Be careful with names (iDoctor - be careful because sounds like apple, could come after you and you'd have to change everything)

Corporations are more complicated

o More levels of structure

Agents of the corp: Shareholders? Officers?

o Officers - because they're employees of the corporation - agents of the corp., can be liable for anything they do o Shareholders - agent of the corp? not at all

• S-corp (similar to LLC)

o Why is it called an s corp? o What is s? ♣ Tax code (have subchapter c, subchapter s) ♣ Go to entity for a small business ♣ First to provide personal liability protection o Rules: ♣ Has to be incorporated in U.S. ♣ Cannot have more than 100 shareholders ♣ 1 class of stock ♣ member requirements - generally want it to be an individual (can be other trusts and estates, some states may say no partnerships allowed) ♣ no foreign investors o LLC - allows foreign investors, s-corp doesn't ♣ Difference: LLC is more flexible

incorporate buildings

o because if something happens to one building, have building, insurance mortgage - cannot sieze other buildings ♣ one corp that owns all the rental props - can lose all rental properties

SOX (Sarbanes Oxley Act)

o knew or should've known test - criminal liable (SOX has increased this) o SOX - attorney client privilege ♣ Anything discussed about business between attorney and ceo is private o Before SOX different

Who Runs:

officers

Board of directors represent _____ any duties owed? and to who?

represents the shareholders, fiduciary duty between them and shareholders and them and officers

Management of closely-held corp.'s

resembles that of a sole proprietorship or partnership, with one or a few of the firm's owners also holding positions as officers and directors.

Who owns:

shareholders

INCORPORATION

steps: state of incur corp name articles of incorp. certificate of incorp.

♣ Ex.: opening up sushi restaurant, submitted documentation, haven't gotten articles of incorp yet and try to lease space

• Cannot sign on behalf of a corp that doesn't exist yet • File personally • Can ask landlord for - novation (I entered into contract in my name, but I would rather have lease in corp name so I am not liable) o Landlord would say no

♣ Threw a company party and called it a shareholders meeting

• The TYCO toga party • Guy went to jail • Million dollar party, over the top • Misusing funds, abusing his power • This money should have been going to shareholders

♣ if you do not follow all the proper procedures and co-mingle funds - can be disastrous

• can say sanda running tsunami restaurant is an alter-ego o take $100 out of cash register - if corp need the documentation, if sole proprietorship - don't need can do it o using corp credit card to pay for kids school books - CO-MINGLING - not going through the proper procedures of giving herself bonus - not in any way related to the business, corporate funds being used for personal use, will rip that protection from you and find you personally liable o go through discovery process when suing ♣ ask for? • Financial records (corp. credit card) o Make sure you have separate checking accounts, keeping good records, and everything you should be doing - if a corp.

Guy had whole fleet of cabs (each cab worth $15k) - to drive any type of car, have to have a minimum amount of insurance ($20,000) o If get into accident w cab, how much money can I expect to get out of it?

♣ $35,000 ♣ incorporated - all you get is car, great way to protect yourself in business

o In the event that you file doc with sec of state and doc not right

♣ Chance you can throw yourself at court asking to not be personally liable o If did it in good faith and not a big mistake ♣ More than likely court will say it's a technical error

o Until you get the certificate of incorp from the sec of state are you a corp?

♣ NO ♣ Any business you do before you are PERSONALLY LIABLE FOR

Piercing the corporate veil and other types of ultra-vires

♣ Show it ♣ Trick someone into believing they were dealing with you personally and not a corp. ♣ CEO "personally guarantees it" - ask for it in writing ♣ To avoid a legal obligation • Can be many reasons for moving assets - show it's the only reason • If can show that, no fraud ♣ Insufficient capital • Sufficient - pay debts • Possible to not capitalize enough