BL 301 Final

Factors That Lead Courts to Pierce the Corporate Veil

1. A party is tricked or misled 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. Alternatively, it 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 such an extent that the corporation has no separate identity.

Incorporation Procedure (18-2b)

1. Select state of incorporation -Because state corporate laws differ, individuals seeking to incorporate a business may look for the states that offer the most advantageous tax or other provisions. 2. Secure corporate name -A new corporation's name cannot be the same as, or deceptively similar to, the name of an existing corporation doing business within the state. All states require the corporation's name to include the word Corporation (Corp.), Incorporated (Inc.), Company (Co.), or Limited (Ltd.). 3. Prepare Articles of Incorporation -The document that is filed with the appropriate state official, usually the secretary of state, when a business is incorporated and that contains basic information about the corporation. The person or persons who execute (sign) the articles are the incorporators. 4. File the articles with Secretary of State -Once the articles of incorporation have been prepared and signed, they are sent to the appropriate state official, usually the secretary of state, along with the required filing fee. In most states, the secretary of state then stamps the articles "Filed" and returns a copy of the articles to the incorporators. Once this occurs, the corporation officially exists.

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 corporations. 3. The shareholders must be individuals, estates, or certain trusts and tax-exempt organizations. Partnerships and nonqualifying trusts cannot be shareholders. Corporations can be shareholders under certain circumstances. 4. The corporation must have no more than one hundred shareholders. 5. The corporation must have only one class of stock, although it is not necessary that all shareholders have the same voting rights. 6. No shareholder of the corporation may be a nonresident alien.

Stock Certificates

A certificate issued by a corporation evidencing the ownership of a specified number of shares in the corporation. In the past, corporations commonly issued stock certificates that evidenced ownership of a specified number of shares in the corporation. Only a few jurisdictions still require physical stock certificates, and shareholders there have the right to demand that the corporation issue certificates (or replace those that were lost or destroyed). Stock is intangible personal property, however, and the ownership right exists independently of the certificate itself. In most states and under RMBCA 6.26, a board of directors may provide that shares of stock will be uncertificated, or "paperless"—that is, no actual, physical stock certificates will be issued. Notice of shareholders' meetings, dividends, and operational and financial reports are distributed according to the ownership lists recorded in the corporation's books.

Stock Warrants

A certificate that grants the owner the option to buy a given number of shares of stock, usually within a set time period.

S Corporation

A close business corporation that has most of the attributes of a corporation, including limited liability, but qualifies under the Internal Revenue Code to be taxed as a partnership. A corporation will automatically be taxed under Subchapter C unless it elects S corporation status. If a corporation has 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.

The Model Business Corporation Act (MBCA)

A codification of modern corporation law that has been influential in shaping state corporation statutes. Today, the majority of state statutes are guided by the most recent version of the MBCA, often referred to as the Revised Model Business Corporation Act (RMBCA).

Holding Company

A company whose business activity is holding shares in another company. Some U.S. corporations use holding companies to reduce or defer their U.S. income taxes. Aka a parent company. Sometimes, a U.S. corporation sets up a holding company in a low-tax offshore environment and then transfers its cash, bonds, stocks, and other investments to the holding company. In general, any profits received by the holding company on these investments are taxed at the rate of the offshore jurisdiction where the company is registered. Once the profits are brought "onshore," though, they are taxed at the federal corporate income tax rate. Any payments received by the shareholders are also taxable at the full U.S. rates.

Crowdfunding

A cooperative activity in which people network and pool funds and other resources via the Internet to assist a cause (such as disaster relief) or invest in a business venture (such as a startup). Sometimes, crowdfunding is used to raise funds for charitable purposes, such as disaster relief, but increasingly it is being used to finance budding entrepreneurs.

Rights of Directors

A corporate director must have certain rights to function properly in that position, including the rights to participation, inspection, and indemnification. Right to Participation The right to participation means that directors are entitled to participate in all board of directors' meetings and have a right to be notified of these meetings. Because the dates of regular board meetings are usually specified in the bylaws, no notice of these meetings is required. If special meetings are called, however, notice is required unless waived by the director [RMBCA 8.23]. Right of Inspection A director also has a right of inspection, which means that each director can access the corporation's books and records, facilities, and premises. Inspection rights are essential for directors to make informed decisions and to exercise the necessary supervision over corporate officers and employees. This right of inspection is almost absolute and cannot be restricted by the articles, bylaws, or any act of the board of directors. Right to Indemnification When a director becomes involved in litigation by virtue of her or his position, the director may have a right to indemnification (reimbursement) for the legal costs, fees, and damages incurred. Most states allow corporations to indemnify and purchase liability insurance for corporate directors [RMBCA 8.51].

Certificate of Authority

A corporation does not have an automatic right to do business in a state other than its state of incorporation. In some instances, it must obtain a certificate of authority in any state in which it plans to do business. Once the certificate has been issued, the corporation generally can exercise in that state all of the powers conferred on it by its home state. If a foreign corporation does business in a state without obtaining a certificate of authority, the state can impose substantial fines and sanctions on that corporation. Note that most state statutes specify certain activities, such as soliciting orders via the Internet, that are not considered "doing business" within the state. For instance, a foreign corporation normally does not need a certificate of authority to sell goods or services via the Internet or by mail.

Alien Corporation

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

Corporation (in-depth)

A corporation is a legal entity created and recognized by state law. This business entity can have one or more owners (called shareholders), and it operates under a name distinct from the names of its owners. Both individuals and other businesses can be shareholders. The corporation substitutes itself for its shareholders when conducting corporate business and incurring liability. Its authority to act and the liability for its actions, however, are separate and apart from the shareholders who own it. A corporation is recognized under U.S. law as a person—an artificial legal person, as opposed to a natural person. As a "person," it enjoys many of the same rights and privileges under state and federal law that U.S. citizens enjoy. For instance, corporations possess the same right of access to the courts as citizens and can sue or be sued. The constitutional guarantees of due process, free speech, and freedom from unreasonable searches and seizures also apply to corporations.

Public Corporation

A corporation owned by a federal, state, or municipal government—not to be confused with a publicly held corporation. Cities and towns that incorporate are common examples. In addition, many federal government organizations, such as the U.S. Postal Service, the Tennessee Valley Authority, and AMTRAK, are public corporations.

Close Corporations

A corporation whose shareholders are limited to a small group of persons, often family members. There is no trading market for the shares. In practice, a close corporation is often operated like a partnership. Aka a closely held, family, or privately held corporation. To prevent a majority shareholder from dominating the company, a close corporation may require that more than a simple majority of the directors approve any action taken by the board. In a larger corporation, such a requirement would typically apply only to extraordinary actions (such as selling all the corporate assets) and not to ordinary business decisions.

Publicly Held Corporation

A corporation whose shares are publicly traded in securities markets, such as the New York Stock Exchange or the NASDAQ. Aka a public company.

Dividends

A distribution of corporate profits to the corporation's shareholders in proportion to the number of shares held.

The Business Judgment Rule

A rule under which courts will not hold corporate officers and directors liable for honest mistakes of judgment and bad business decisions that were made in good faith. Courts give significant deference to the decisions of corporate directors and officers, and consider the reasonableness of a decision at the time it was made, without the benefit of hindsight. Thus, corporate decision makers are not subjected to second-guessing by shareholders or others in the corporation. The business judgment rule will apply as long as the director or officer: 1. Took reasonable steps to become informed about the matter. 2. Had a rational basis for her or his decision. 3. Did not have a conflict between her or his personal interest and the interest of the corporation. The business judgment rule provides broad protections to corporate decision makers. In fact, most courts will apply the rule unless there is evidence of bad faith, fraud, or a clear breach of fiduciary duties.

Preferred Stock

A security that entitles the holder to payment of fixed dividends and that has priority over common stock in the distribution of assets on the corporation's dissolution.

Bonds

A security that evidences a corporate (or government) debt. Bonds are issued by business firms and by governments at all levels as evidence of funds they are borrowing from investors. Bonds normally have a designated maturity date—the date when the principal, or face amount, of the bond is returned to the bondholder. Bondholders also receive fixed-dollar interest payments, usually semiannually, during the period of time prior to maturity. For that reason, they are sometimes referred to as fixed-income securities. Because debt financing represents a legal obligation of the corporation, various features and terms of a particular bond issue are specified in a lending agreement. Of course, not all debt is in the form of bonds. For instance, some debt is in the form of accounts payable and notes payable, which typically are short-term debts. Bonds are simply a way for the corporation to split up its long-term debt so that it can be more easily marketed.

Common Stock

A security that evidences ownership in a corporation. A share of common stock gives the owner a proportionate interest in the corporation with regard to control, earnings, and net assets. Common stock is lowest in priority with respect to payment of dividends and distribution of the corporation's assets on dissolution. Common stock provides an interest in the corporation with regard to control, earnings, and net assets.

Benefit Corporation

A type of for-profit corporation, available by statute in a number of states, that seeks to have a material positive impact on society and the environment. Benefit corporations differ from traditional corporations in the following ways: 1. Purpose 2. Accountability 3. Transparency

First Organizational Meeting

After incorporation, the first organizational meeting must be held. If the articles of incorporation named the initial board of directors, then the directors, by majority vote, call the meeting. If the articles did not name the directors (as is typical), then the incorporators hold the meeting to elect the directors and complete any other business necessary.

S Corporations (In regards to taxes)

An S corporation is treated differently than a regular corporation for tax purposes. An S corporation is taxed like a partnership, so the corporate income passes through to the shareholders, who pay personal income tax on it. This treatment enables the S corporation to avoid the double taxation imposed on regular corporations. In addition, the shareholders' tax brackets may be lower than the tax bracket that the corporation would have been in if the tax had been imposed at the corporate level. In spite of these tax benefits, the S corporation has lost much of its appeal. The newer limited liability business forms (such as LLCs, LPs, and LLPs) offer similar tax advantages and greater flexibility.

Voting Trust

An agreement (trust contract) under which legal title to shares of corporate stock is transferred to a trustee who is authorized by the shareholders to vote the shares on their behalf.

Shareholder Agreement

An agreement between shareholders that restricts the transferability of shares, often entered into for the purpose of maintaining proportionate control of a close corporation. A shareholder agreement can also provide for proportional control when one of the original shareholders dies. The decedent's shares of stock in the corporation can be divided in such a way that the proportionate holdings of the survivors, and thus their proportionate control, will be maintained.

Stocks

An ownership (equity) interest in a corporation, measured in units of shares. Equity securities The true ownership of a corporation is represented by common stock.

Double Taxation

Another important aspect of corporate taxation is that corporate profits can be subject to double taxation. The company pays tax on its profits. Then, if the profits are passed on to the shareholders as dividends, the shareholders must also pay income tax on them. (This is true unless the dividends represent distributions of capital, which are returns of holders' investments in the stock of the company.) The corporation normally does not receive a tax deduction for dividends it distributes. This double-taxation feature is one of the major disadvantages of the corporate form.

Dividends

As mentioned, a dividend is a distribution of corporate profits or income ordered by the directors and paid to the shareholders in proportion to their shares in the corporation. Dividends can be paid in cash, property, stock of the corporation that is paying the dividends, or stock of other corporations. State laws vary, but each state determines the general circumstances and legal requirements under which dividends are paid. State laws also control the sources of revenue to be used. All states allow dividends to be paid from the undistributed net profits earned by the corporation, for instance. A number of states allow dividends to be paid out of any surplus.

Proxies

Authorization to represent a corporate shareholder to serve as his or her agent and vote his or her shares in a certain manner. It usually is not practical for owners of only a few shares of stock of publicly traded corporations to attend a shareholders' meeting. Therefore, the law allows stockholders to appoint another person as their agent to vote their shares at the meeting. The agent's formal authorization to vote the shares is called a proxy (from the Latin procurare, meaning "to manage or take care of"). Proxy materials are sent to all shareholders before shareholders' meetings. Management often solicits proxies, but any person can solicit proxies to concentrate voting power. Proxies have been used by groups of shareholders as a device for taking over a corporation. Proxies normally are revocable (can be withdrawn), unless they are specifically designated as irrevocable and coupled with an interest. A proxy is coupled with an interest when, for instance, the person receiving the proxies from shareholders has agreed to buy their shares. Under RMBCA 7.22(c), proxies are valid for eleven months, unless the proxy agreement mandates a longer period.

Other Voting Techniques

Before a shareholders' meeting, a group of shareholders can agree in writing to vote their shares together in a specified manner. Such agreements, called shareholder voting agreements, usually are held to be valid and enforceable. A shareholder can also vote by proxy, as noted earlier. Another technique is for shareholders to enter into a voting trust. A voting trust is an agreement (a trust contract) under which a shareholder assigns the right to vote his or her shares to a trustee, usually for a specified period of time. The trustee is then responsible for voting the shares on behalf of all the shareholders in the trust. The shareholder retains all rights of ownership (for instance, the right to receive dividend payments) except the power to vote the shares [RMBCA 7.30].

Transfer of Shares in Close Corporations

By definition, a close corporation has a small number of shareholders. Thus, the transfer of one shareholder's shares to someone else can cause serious management problems. The other shareholders may find themselves required to share control with someone they do not know or like. To avoid this situation, a close corporation can restrict the transferability of shares to outside persons. Shareholders can be required to offer their shares to the corporation or to the other shareholders before selling them to an outside purchaser. In fact, in a few states close corporations must transfer shares in this manner under state statutes.

Private Equity Capital

Capital funds invested by a private equity firm in an existing corporation, usually to purchase and reorganize it. Usually, a private equity firm buys an entire corporation and then reorganizes it. Sometimes, divisions of the purchased company are sold off to pay down debt. Ultimately, the private equity firm may sell shares in the reorganized (and perhaps more profitable) company to the public in an initial public offering (IPO). Then the private equity firm can make profits by selling its shares in the company to the public.

Conflicts of Interest

Corporate directors often have many business affiliations, and a director may sit on the board of more than one corporation. Of course, directors are precluded from entering into or supporting businesses that operate in direct competition with corporations on whose boards they serve. Their fiduciary duty requires them to make a full disclosure of any potential conflicts of interest that might arise in any corporate transaction [RMBCA 8.60]. Sometimes, a corporation enters into a contract or engages in a transaction in which an officer or director has a personal interest. The director or officer must make a full disclosure of the nature of the conflicting interest and all facts pertinent to the transaction. He or she must also abstain from voting on the proposed transaction. When these rules are followed, the transaction can proceed. Otherwise, directors would be prevented from ever having financial dealings with the corporations they serve.

Corporate Officers and Executives

Corporate officers and other executive employees are hired by the board of directors. At a minimum, most corporations have a president, one or more vice presidents, a secretary, and a treasurer. In most states, an individual can hold more than one office, such as president and secretary, and can be both an officer and a director of the corporation. In addition to carrying out the duties articulated in the bylaws, corporate and managerial officers act as agents of the corporation. Therefore, the ordinary rules of agency generally apply to their employment. Corporate officers and other high-level managers are employees of the company, so their rights are defined by employment contracts. Nevertheless, the board of directors normally can remove a corporate officer at any time with or without cause. If the directors remove an officer in violation of the terms of an employment contract, however, the corporation may be liable for breach of contract.

Transfer of Shares

Corporate stock represents an ownership right in intangible personal property. The law generally recognizes the owner's right to transfer stock to another person unless there are valid restrictions on its transferability, such as frequently occur with close corporation stock. When shares are transferred, a new entry is made in the corporate stock book to indicate the new owner. Until the corporation is notified and the entry is complete, all rights—including voting rights, notice of shareholders' meetings, and the right to dividend distributions—remain with the current record owner.

Nonprofit Corporation

Corporations formed for purposes other than making a profit are called nonprofit or not-for-profit corporations. Private hospitals, educational institutions, charities, and religious organizations, for instance, are frequently organized as nonprofit corporations. The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without exposing the individual members to personal liability.

Private Corporation

Created either wholly or in part for private benefit—that is, for profit. Most corporations are private. Although they may serve a public purpose, as a public electric or gas utility does, they are owned by private persons rather than by a government.

Duty to Make Informed Decisions

Directors and officers are expected to be informed on corporate matters and to conduct a reasonable investigation of the situation before making a decision. They must, for instance, attend meetings and presentations, ask for information from those who have it, read reports, and review other written materials. In other words, directors and officers must investigate, study, and discuss matters and evaluate alternatives before making a decision. They cannot decide on the spur of the moment without adequate research. Although directors and officers are expected to act in accordance with their own knowledge and training, they are also normally entitled to rely on information given to them by certain other persons. Under the laws of most states and Section 8.30(b) of the RMBCA, such persons include competent officers or employees, professionals such as attorneys and accountants, and committees of the board of directors. (The committee must be one on which the director does not serve, however.) The reliance must be in good faith to insulate a director from liability if the information later proves to be inaccurate or unreliable.

Liability of Directors and Officers

Directors and officers are exposed to liability on many fronts. They can be held liable for negligence in certain circumstances, as previously discussed. They may also be held liable for the crimes and torts committed by themselves or by employees under their supervision. Additionally, if shareholders perceive that the corporate directors are not acting in the best interests of the corporation, they may sue the directors on behalf of the corporation. (This is known as a shareholder's derivative suit, which will be discussed later in this chapter.) Directors and officers can also be held personally liable under a number of statutes, such as statutes enacted to protect consumers or the environment.

Duty of Care

Directors and officers must exercise due care in performing their duties. The standard of due care has been variously described in judicial decisions and codified in many state corporation codes. Generally, it requires a director or officer to: 1. Act in good faith (honestly). 2. Exercise the care that an ordinarily prudent (careful) person would exercise in similar circumstances. 3. Do what she or he believes is in the best interests of the corporation [RMBCA 8.30(a), 8.42(a)]. If directors or officers fail to exercise due care and the corporation or its shareholders suffer harm as a result, the directors or officers can be held liable for negligence. (An exception is made if the business judgment rule applies, as discussed shortly.)

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' votes at board of directors' meetings should be entered into the minutes. Sometimes, an individual director disagrees with the majority's vote (which becomes an act of the board of directors). Unless a dissent is entered in the minutes, the director is presumed to have assented. If the directors are later held liable for mismanagement as a result of a decision, dissenting directors are rarely held individually liable to the corporation. For this reason, a director who is absent from a given meeting sometimes registers a dissent with the secretary of the board regarding actions taken at the meeting.

Illegal Dividends

Dividends are illegal if they are improperly paid from an unauthorized account or if their payment causes the corporation to become insolvent (unable to pay its debts as they come due). Generally, shareholders must return illegal dividends only if they knew that the dividends were illegal when the payment was received (or if the dividends were paid when the corporation was insolvent). Whenever dividends are illegal or improper, the board of directors can be held personally liable for the amount of the payment.

Venture Capital

Financing provided to new business ventures by professional, outside investors—that is, venture capitalists, usually groups of wealthy investors and securities firms. Venture capital investments are high risk—the investors must be willing to lose all of their invested funds—but offer the potential for well-above-average returns in the future. To obtain venture capital financing, the start-up business typically gives up a share of its ownership to the venture capitalists. In addition to funding, venture capitalists may provide managerial and technical expertise, and they nearly always are given some control over the new company's decisions. Many Internet-based companies, such as Google and Amazon, were initially financed by venture capital.

Quorum Requirements

For shareholders to act during a meeting, a quorum must be present. Generally, a quorum exists when shareholders holding more than 50 percent of the outstanding shares are present. State laws often permit the articles of incorporation to set higher or lower quorum requirements, however. In some states, obtaining the unanimous written consent of shareholders is a permissible alternative to holding a shareholders' meeting [RMBCA 7.25]. Once a quorum is present, voting can proceed. If a state statute requires specific voting procedures, the corporation's articles or bylaws must be consistent with the statute. A majority vote of the shares represented at the meeting usually is required to pass resolutions. At times, more than a simple majority vote is required, either by a state statute or by the corporate articles. Extraordinary corporate matters, such as a merger, consolidation, or dissolution of the corporation, require approval by a higher percentage of all corporate shares entitled to vote [RMBCA 7.27].

Securities

Generally, stocks, bonds, or other items that represent an ownership interest in a corporation or a promise of repayment of debt by a corporation.

De Jure Corporations

If a corporation has substantially complied with all conditions precedent to incorporation, the corporation is said to have de jure (rightful and lawful) existence. In most states and under RMBCA 2.03(b), the secretary of state's filing of the articles of incorporation is conclusive proof that all mandatory statutory provisions have been met [RMBCA 2.03(b)]. Sometimes, the incorporators fail to comply with all statutory mandates. If the defect is minor, such as an incorrect address listed on the articles of incorporation, most courts will overlook the defect and find that a de jure corporation exists.

De Facto Corporations

If the defect in formation is substantial, such as a corporation's failure to hold an organizational meeting to adopt bylaws, the outcome will vary depending on the jurisdiction. Some states, including Mississippi, New York, Ohio, and Oklahoma, recognize the common law doctrine of de facto corporation. In those states, the courts will treat a corporation as a legal corporation despite a defect in its formation if the following three requirements are met: 1. A state 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 already undertaken to do business as a corporation.

Board of Directors

In a corporation, the responsibility for the overall management of the firm is entrusted to a board of directors, whose members are elected by the shareholders. The board of directors makes the policy decisions and hires corporate officers and other employees to run the daily business operations.

Foreign Corporation

In a given state, a corporation that does business in that state but is not incorporated there. A corporation formed in one state but doing business in another.

Domestic Corporation

In a given state, a corporation that is organized under the law of that state.

Duties of Majority Shareholders

In some instances, a majority shareholder is regarded as having a fiduciary duty to the corporation and to the minority shareholders. This duty arises when a single shareholder (or a few shareholders acting in concert) owns a sufficient number of shares to exercise de facto control over the corporation. In these situations, the majority shareholder owes a fiduciary duty to the minority shareholders. When a majority shareholder breaches her or his fiduciary duty to a minority shareholder, the minority shareholder can sue for damages. A breach of fiduciary duties by those who control a close corporation normally constitutes what is known as oppressive conduct. A common example of a breach of fiduciary duty occurs when the majority shareholders "freeze out" the minority shareholders and exclude them from certain benefits of participating in the firm.

Compensation of Directors

In the past, corporate directors were rarely compensated. Today, directors are often paid at least nominal sums. In large corporations, they may receive more substantial compensation because of the time, work, effort, and especially risk involved. Most states permit the corporate articles or bylaws to authorize compensation for directors. In fact, the Revised Model Business Corporation Act (RMBCA) states that unless the articles or bylaws provide otherwise, the board itself may set the directors' compensation [RMBCA 8.11]. Directors also receive indirect benefits, such as business contacts and prestige, and other rewards, such as stock options. In many corporations, directors are also chief corporate officers (such as president or chief executive officer) and receive compensation in their managerial positions. A director who is also an officer of the corporation is referred to as an inside director, whereas a director who does not hold a management position is an outside director. Typically, a corporation's board of directors includes both inside and outside directors.

Promotional Activities

In the past, preliminary steps were taken to organize and promote a business prior to incorporating. Contracts were made with investors and others on behalf of the future corporation. Today, due to the relative ease of forming a corporation in most states, persons incorporating their business rarely, if ever, engage in preliminary promotional activities. Nevertheless, businesspersons should understand that they are personally liable for any preincorporation contracts made with investors, accountants, or others on behalf of the future corporation. Personal liability continues until the newly formed corporation assumes liability for the preincorporation contracts through a novation.

Duty of Loyalty

Loyalty can be defined as faithfulness to one's obligations and duties. In the corporate context, the duty of loyalty requires directors and officers to subordinate their personal interests to the welfare of the corporation. For instance, a director should not oppose a transaction that is in the corporation's best interest simply because pursuing it may cost the director his or her position. Directors cannot use corporate funds or confidential corporate information for personal advantage and must refrain from self-dealing. Cases dealing with the duty of loyalty typically involve one or more of the following: 1. Competing with the corporation. 2. Usurping (taking personal advantage of) a corporate opportunity. 3. Pursuing an interest that conflicts with that of the corporation. 4. Using information that is not available to the public to make a profit trading securities (insider trading). 5. Authorizing a corporate transaction that is detrimental to minority shareholders. 6. Selling control over the corporation.

Cumulative Voting

Most states permit, and many require, shareholders to elect directors by cumulative voting, a voting method designed to allow minority shareholders to be represented on the board of directors. When cumulative voting is not required, the entire board can be elected by a majority of shares.

Shareholder Liability

Normally, corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments. In certain limited situations, however, a court can pierce the corporate veil and impose liability on shareholders for the corporation's obligations. Additionally, creditors often will not extend credit to small companies unless the shareholders assume personal liability, as guarantors, for corporate obligations.

Duties and Liabilities of Shareholders

One of the hallmarks of the corporate form of organization is that shareholders are not personally liable for the debts of the corporation. If the corporation fails, the shareholders can lose their investments, but that generally is the limit of their liability. As discussed previously, in certain instances, a court will pierce the corporate veil (disregard the corporate entity) and hold the shareholders individually liable. But these situations are the exception, not the rule. A shareholder can also be personally liable in certain other rare instances. One relates to illegal dividends, which were mentioned previously. Another relates to watered stock. Finally, in certain instances, a majority shareholder who engages in oppressive conduct or attempts to exclude minority shareholders from receiving certain benefits can be held personally liable.

Professional Corporations

Professionals such as physicians, lawyers, dentists, and accountants can incorporate. A professional corporation typically is identified by the letters P.C. (professional corporation), S.C. (service corporation), or P.A. (professional association). In general, the laws governing the formation and operation of professional corporations are similar to those governing ordinary business corporations. There are some differences in terms of liability, however, because the shareholder-owners are professionals who are held to a higher standard of conduct. For liability purposes, some courts treat professional corporations somewhat like partnerships and hold each professional liable for malpractice committed within the scope of the business by others in the firm.

Shareholder Voting

Shareholders exercise 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. Each common shareholder normally is entitled to one vote per share. The articles of incorporation can exclude or limit voting rights, particularly for certain classes of shares. For instance, owners of preferred shares are usually denied the right to vote [RMBCA 7.21]. If a state statute requires specific voting procedures, the corporation's articles or bylaws must be consistent with the statute.

Inspection Rights

Shareholders in a corporation enjoy both common law and statutory inspection rights. The RMBCA provides that every shareholder is entitled to examine specified corporate records, including voting lists [RMBCA 7.20, 16.02]. The shareholder may inspect in person, or an attorney, accountant, or other authorized individual can do so as the shareholder's agent. In some states, a shareholder must have held her or his shares for a minimum period of time immediately preceding the demand to inspect or must hold a certain percentage of outstanding shares. A shareholder has a right to inspect and copy corporate books and records only for a proper purpose, and the request to inspect must be made in advance. A shareholder who is denied the right of inspection can seek a court order to compel the inspection. The power of inspection is fraught with potential abuses, and the corporation is allowed to protect itself from them. For instance, a shareholder can properly be denied access to corporate records to prevent harassment or to protect trade secrets or other confidential corporate information.

Shareholders' Powers

Shareholders must approve fundamental changes affecting the corporation before the changes can be implemented. Hence, 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 corporation's assets. Some of these powers are subject to prior board approval. Shareholder approval may also be requested (though it is not required) for certain other actions, such as to approve an independent auditor. Shareholders also have the power to vote to elect or remove members of the board of directors. As described earlier, the first board of directors is either named in the articles of incorporation or chosen by the incorporators to serve until the first shareholders' meeting. From that time on, selection and retention of directors are exclusively shareholder functions. Directors usually serve their full terms. If the shareholders judge them unsatisfactory, they are simply not reelected. Shareholders have the inherent power, however, to remove a director from office for cause (breach of duty or misconduct) by a majority vote. Some state statutes (and some articles of incorporation) permit removal of directors without cause by the vote of a majority of the shareholders entitled to vote.

Shareholders' Meetings

Shareholders' meetings must occur at least annually. In addition, special meetings can be called to deal with urgent matters. A corporation must notify its shareholders of the date, time, and place of an annual or special shareholders' meeting at least ten days, but not more than sixty days, before the meeting date [RMBCA 7.05]. (The date and time of the annual meeting can be specified in the bylaws.) Notice of a special meeting must include a statement of the purpose of the meeting, and business transacted at the meeting is limited to that purpose. The RMBCA does not specify how the notice must be given. Most corporations do specify in their bylaws the acceptable methods of notifying shareholders about meetings. Also, some states' incorporation statutes outline the means of notice that a corporation can use in that jurisdiction. For instance, in Alaska, notice may be given in person, by mail, or by fax, e-mail, blog, or Web post—as long as the shareholder has agreed to that electronic method.

Watered Stock

Shares of stock issued by a corporation for which the corporation receives, as payment, less than the fair market value of the shares. When a corporation issues shares for less than their fair market value, the shares are referred to as watered stock. Usually, the shareholder who receives watered stock must pay the difference to the corporation (the shareholder is personally liable). In some states, the shareholder who receives watered stock may be liable to creditors of the corporation for unpaid corporate debts.

Corporation by Estoppel

Sometimes, a business association holds itself out to others as being a corporation when it has made no attempt to incorporate. In those situations, the firm normally will be estopped (prevented) from denying corporate status in a lawsuit by a third party. The estoppel doctrine most commonly applies when a third party contracts with an entity that claims to be a corporation but has not filed articles of incorporation. It may also apply when a third party contracts with a person claiming to be an agent of a corporation that does not in fact exist. When justice requires, courts in some states will treat an alleged corporation as if it were an actual corporation for the purpose of determining rights and liabilities in particular circumstances. Recognition of corporate status does not extend beyond the resolution of the problem at hand.

Misappropriation of Close Corporation Funds

Sometimes, a majority shareholder in a close corporation takes advantage of his or her position and misappropriates company funds. In such situations, the normal remedy for the injured minority shareholders is to have their shares appraised and to be paid the fair market value for them.

The Alter-Ego Theory

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

Election of Directors

Subject to statutory limitations, the number of directors is set forth in the corporation's articles or bylaws. Historically, the minimum number of directors has been three, but today many states permit fewer. Normally, the incorporators may appoint the first board of directors in the articles of incorporation. If not, then the incorporators hold a meeting after incorporation to elect the directors and complete any other business necessary (such as adopting bylaws). The initial board serves until the first annual shareholders' meeting. Subsequent directors are elected by a majority vote of the shareholders. A director usually serves for a term of one year—from annual meeting to annual meeting. Most state statutes permit longer and staggered terms. A common practice is to elect one-third of the board members each year for a three-year term. In this way, there is greater management continuity. A director can be removed for cause—that is, for failing to perform a required duty—either as specified in the articles or bylaws or by shareholder action. The board of directors may also have the power to remove a director for cause, subject to shareholder review. In most states, a director cannot be removed without cause unless the shareholders reserved the right to do so at the time of election. When a vacancy on the board occurs, such as if a director dies or resigns, either the shareholders or the board itself can fill the vacant position, depending on state law or on the provisions of the bylaws. Often, for instance, an election is held, and shareholders vote to fill the vacancy. Note that even when an election is authorized, a court can invalidate the results if the directors have attempted to manipulate the election in order to reduce the shareholders' influence.

Rules for Proxies and Shareholder Proposals

The Securities and Exchange Commission (SEC) regulates the purchase and sale of securities. The SEC has special provisions relating to proxies and shareholder proposals. SEC Rule 14a-8 provides that all shareholders who own stock worth at least $1,000 are eligible to submit proposals for inclusion in corporate proxy materials. The corporation is required to include information on whatever proposals will be considered at the shareholders' meeting along with proxy materials. Only those proposals that relate to significant policy considerations, not ordinary business operations, must be included. Under the SEC's e-proxy rules, all public companies must post their proxy materials on the Internet and notify shareholders how to find that information. Although the law requires proxy materials to be posted online, public companies may also send the materials to shareholders by other means, including paper documents and DVDs sent by mail.

Shareholders

The acquisition of a share of stock makes a person an owner and a shareholder in a corporation. Shareholders thus own the corporation. Although they have no legal title to corporate property, such as buildings and equipment, they do have an equitable (ownership) interest in the firm. As a general rule, shareholders have no responsibility for the daily management of the corporation, although they are ultimately responsible for choosing the board of directors, which does have such control. Ordinarily, corporate officers and other employees owe no direct duty to individual shareholders (unless some contract or special relationship exists between them in addition to the corporate relationship). The duty of officers and directors is to act in the best interests of the corporation and its shareholder-owners as a whole.

Piercing the Corporate Veil

The action of a court to disregard the corporate entity and hold the shareholders personally liable for corporate debts and obligations. Generally, courts pierce the veil when the corporate privilege is abused for personal benefit or when the corporate business is treated so carelessly that it is indistinguishable from that of a controlling shareholder. When the facts show that great injustice would result from a shareholder's use of a corporation to avoid individual responsibility, a court will look behind the corporate structure to the individual shareholders.

Board of Directors' Meetings

The board of directors conducts business by holding formal meetings with recorded minutes. The dates of regular meetings are usually established in the articles or bylaws or by board resolution, and ordinarily no further notice is required. Special meetings can be called as well, with notice sent to all directors. Most states allow directors to participate in board of directors' meetings from remote locations. Directors can participate via telephone, Web conferencing, or Skype, provided that all the directors can simultaneously hear each other during the meeting [RMBCA 8.20]. Normally, a majority of the board of directors constitutes a quorum [RMBCA 8.24]. A quorum is the minimum number of members of a body of officials or other group who must be present for business to be validly transacted. Some state statutes specifically allow corporations to set a quorum at less than a majority but not less than one-third of the directors. Once a quorum is present, the directors transact business and vote on issues affecting the corporation Each director present at the meeting has one vote. Ordinary matters generally require a simple majority vote, but certain extraordinary issues may require a greater-than-majority vote.

Role of Directors and Officers

The board of directors is the ultimate authority in every corporation. Directors have responsibility for all policy-making decisions necessary to the management of all corporate affairs. Additionally, the directors must act as a body in carrying out routine corporate business. The board selects and removes the corporate officers, determines the capital structure of the corporation, and declares dividends. Each director has one vote, and customarily the majority rules. Directors are sometimes inappropriately characterized as agents because they act on behalf of the corporation. No individual director, however, can act as an agent to bind the corporation. As a group, directors collectively control the corporation in a way that no agent is able to control a principal. In addition, although directors occupy positions of trust and control over the corporation, they are not trustees, because they do not hold title to property for the use and benefit of others. Few qualifications are required for directors. Only a handful of states impose minimum age and residency requirements. A director may be a shareholder, but that is not necessary (unless the articles of incorporation or bylaws require ownership interest).

Corporation

The corporation is a creature of statute. A corporation is an artificial being, existing only in law and being neither tangible nor visible. Its existence generally depends on state law, although some corporations, especially public organizations, are created under federal law. Each state has its own body of corporate law, and these laws are not entirely uniform. Textbook Definition: A corporation is a firm that is authorized by statute to act as legal entity separate and distinct from its owners (shareholders).

Voting Lists

The corporation prepares a voting list before each shareholders' meeting. Ordinarily, only persons whose names appear on the corporation's stockholder records as owners are entitled to vote. The voting list contains the name and address of each shareholder as shown on the corporate records on a given cutoff date, or record date. (Under RMBCA 7.07, the bylaws or board of directors may fix a record date that is as much as seventy days before the meeting.) The voting list also includes the number of voting shares held by each owner. The list is usually kept at the corporate headquarters and must be made available for shareholder inspection [RMBCA 7.20].

Duties and Liabilities of Directors and Officers

The duties of corporate directors and officers are similar because both groups are involved in decision making and are in positions of control. Directors and officers are considered to be fiduciaries of the corporation because their relationship with the corporation and its shareholders is one of trust and confidence. As fiduciaries, directors and officers owe ethical—and legal—duties to the corporation and to the shareholders as a group. These fiduciary duties include the duty of care and the duty of loyalty.

Express Powers

The express powers of a corporation are found in its articles of incorporation, in the law of the state of incorporation, and in the state and federal constitutions. Corporate bylaws and the resolutions of the corporation's board of directors also establish express powers. The following order of priority is used if a conflict arises among the various documents involving a corporation: The U.S. Constitution. State constitutions. State statutes. The articles of incorporation. Bylaws. Resolutions of the board of directors. It is important that the bylaws set forth the specific operating rules of the corporation. State corporation statutes frequently provide default rules that apply if the company's bylaws are silent on an issue.

Bylaws

The internal rules of management adopted by a corporation at its first organizational meeting. Usually, the most important function of this meeting is the adoption of bylaws, which are the internal rules of management for the corporation. The bylaws cannot conflict with the state corporation statute or the articles of incorporation [RMBCA 2.06]. Under the RMBCA, the shareholders may amend or repeal the bylaws. The board of directors may also amend or repeal the bylaws, unless the articles of incorporation or provisions of the state corporation statute reserve this power to the shareholders [RMBCA 10.20]. The bylaws typically describe such matters as voting requirements for shareholders, the election of the board of directors, and the methods of replacing directors. Bylaws also frequently outline the manner and time of holding shareholders' and board meetings.

Retained Earnings

The portion of a corporation's profits that has not been paid out as dividends to shareholders.

A Potential Problem for Close Corporations

The potential for corporate assets to be used for personal benefit is especially great in a close corporation. In such a corporation, the separate status of the corporate entity and the shareholders (often family members) must be carefully preserved. Practices that invite trouble for a close corporation include the commingling of corporate and personal funds and the shareholders' continuous personal use of corporate property (for instance, vehicles). Typically, courts are reluctant to hold shareholders in close corporations personally liable for corporate obligations unless there is some evidence of fraud or wrongdoing.

Preemptive Rights

The right of a shareholder in a corporation to have the first opportunity to purchase a new issue of that corporation's stock in proportion to the amount of stock already owned by the shareholder. Sometimes, the articles of incorporation grant preemptive rights to shareholders [RMBCA 6.30]. 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. Generally, preemptive rights must be exercised within a specific time period (usually thirty days). A shareholder who is given preemptive rights can purchase a percentage of the new shares being issued that is equal to the percentage of shares she or he already holds in the company. This allows each shareholder to maintain her or his proportionate control, voting power, and financial interest in the corporation. Preemptive rights are most important in close corporations because each shareholder owns a relatively small number of shares but controls a substantial interest in the corporation. Without preemptive rights, it would be possible for a shareholder to lose his or her proportionate control over the firm. Nevertheless, preemptive rights do not exist unless provided for in the articles of incorporation.

Ultra Vires Doctrine

The term ultra vires means "beyond the power." In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts. In the past, most cases dealing with ultra vires acts involved contracts made for unauthorized purposes. Now, because the articles of incorporation of most private corporations do not state a specific purpose, the ultra vires doctrine has declined in importance. Nevertheless, cases involving ultra vires acts are sometimes brought against nonprofit corporations or municipal (public) corporations.

Commingled

To put funds or goods together into one mass so that they are mixed to such a degree that they no longer have separate identities.

Remedies for Ultra Vires Acts

Under Section 3.04 of the RMBCA, shareholders can seek an injunction from a court to prevent (or stop) the corporation from engaging in ultra vires acts. The attorney general in the state of incorporation can also bring an action to obtain an injunction against the ultra vires transactions or to seek dissolution of the corporation. The corporation or its shareholders (on behalf of the corporation) can seek damages from the officers and directors who were responsible for the ultra vires acts.

Criminal Acts (Corporations)

Under modern criminal law, a corporation may be held liable for the criminal acts of its agents and employees. Although corporations cannot be imprisoned, they can be fined. (Of course, corporate directors and officers can be imprisoned, and many have been.) In addition, under sentencing guidelines for crimes committed by corporate employees (white-collar crimes), corporations can face fines amounting to hundreds of millions of dollars.

Committees of the Board of Directors

When a board of directors has a large number of members and must deal with myriad complex business issues, meetings can become unwieldy. Therefore, the boards of large, publicly held corporations typically create committees of directors and delegate certain tasks to these committees. By focusing on specific subjects, committees can increase the efficiency of the board. Two common types of committees are the executive committee and the audit committee. An executive committee handles interim management decisions between board meetings. It is limited to dealing with ordinary business matters and does not have the power to declare dividends, amend the bylaws, or authorize the issuance of stock. The audit committee is responsible for the selection, compensation, and oversight of the independent public accountants that audit the firm's financial records. The Sarbanes-Oxley Act requires all publicly held corporations to have an audit committee.

Implied Powers

When a corporation is created, it acquires certain implied powers. Barring express constitutional, statutory, or other prohibitions, the corporation has the implied power to perform all acts reasonably necessary to accomplish its corporate purposes. For this reason, a corporation has the implied power to borrow and lend funds within certain limits and to extend credit to parties with whom it has contracts. Most often, the president or chief executive officer of the corporation signs the necessary documents on behalf of the corporation. Such corporate officers have the implied power to bind the corporation in matters directly connected with the ordinary business affairs of the enterprise. There are limits to what a corporate officer can do. For instance, a corporate officer does not have the authority to bind the corporation to an action that will greatly affect the corporate purpose or undertaking, such as the sale of substantial corporate assets.

Shareholder

When an individual purchases a share of stock in a corporation, that person becomes a shareholder and an owner of the corporation. Unlike the partners in a partnership, the body of shareholders can change constantly without affecting the continued existence of the corporation. A shareholder can sue the corporation, and the corporation can sue a shareholder. Additionally, under certain circumstances, a shareholder can sue on behalf of a corporation.

The Directors' Failure to Declare a Dividend

When directors fail to declare a dividend, shareholders can ask a court to compel the directors to do so. 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. Often, a corporation accumulates large cash reserves for a legitimate corporate purpose, such as expansion or research. The mere fact that the firm has sufficient earnings or surplus available to pay a dividend normally is not enough to compel the directors to declare a dividend. The courts are reluctant to interfere with corporate operations and will not compel directors to declare dividends unless abuse of discretion is clearly shown.

Shareholder Proposals

When shareholders want to change a company policy, they can put their ideas up for a shareholder vote. They do this by submitting a shareholder proposal to the board of directors and asking the board to include the proposal in the proxy materials that are sent to all shareholders before meetings.

The Shareholder's 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. If the corporate directors fail to bring a lawsuit, shareholders can do so "derivatively" in what is known as a shareholder's derivative suit. The right of shareholders to bring a derivative action is especially important when the wrong suffered by the corporation results from the actions of the corporate directors and officers. For obvious reasons, the directors and officers would probably be unwilling to take any action against themselves. Before shareholders can bring a derivative suit, they must submit a written demand to the corporation, asking the board of directors to take appropriate action [RMBCA 7.40]. The directors then have ninety days in which to act. Only if they refuse to do so can the derivative suit go forward. In addition, a court will dismiss a derivative suit if a majority of the directors or an independent panel determines in good faith that the lawsuit is not in the best interests of the corporation [RMBCA 7.44]. When shareholders bring a derivative suit, they are not pursuing rights or benefits for themselves personally but are acting as guardians of the corporate entity. Therefore, if the suit is successful, any damages recovered normally go into the corporation's treasury, not to the shareholders personally.

Corporate Taxation

Whether a corporation retains its profits or passes them on to the shareholders as dividends, those profits are subject to income taxation by various levels of government. Failure to pay taxes can lead to severe consequences. The state can suspend the organization's corporate status until the taxes are paid and can even dissolve the corporation for failing to pay taxes.

Formula

With cumulative voting, each shareholder is entitled to a total number of votes equal to the number of board members to be elected multiplied by the number of voting shares that the shareholder owns. The shareholder can cast all of these votes for one candidate or split them among several nominees for director. All candidates stand for election at the same time.