Chapter 15 Corporations McGraw-Hill/Irwin Copyright 2011 by The

Chapter 15 Corporations McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Overview The governing laws and categories. The rules governing formation.

Personal liability of the principals for corporate liabilities and debts. Capitalization, taxation, and structure. The duties of corporate managers, officers and directors, to the owners. 15-2 CORPORATIONS A corporation is fictitious legal entity that exists as an independent person

separate from its principals. 15-3 Privately Held vs Publicly Held The most common category is a privately held corporation. Privately held corporations are those that do not sell ownership interests through sales via a broker to the general public or

to financial institutions or investors. 15-4 Privately Held vs Publicly Held When a privately held corporation wishes to fund capitalization through the sale of ownership interest to the general public and commercial investors, the principals pursue an Initial Public Offering (IPO) and

then continue their corporate existence as a publicly held corporation. 15-5 Domestic In the state of its incorporation, a corporation is referred to as a domestic corporation.

15-6 Foreign A corporation that transacts business in a state other than its state of incorporation is known as a foreign corporation in the other state. 15-7

Alien A corporation formed outside the United States that transacts business in the United States is referred to as an alien corporation. 15-8 Nonprofit Nonprofit corporations are those with no

profit-seeking owners, but rather exist to perform some service to the public at large (e.g., charities, educational institutions). 15-9 Public corporation Public corporations are those formed by a government body to serve the public at large, such as public mass transit.

15-10 Professional corporations Professional corporations are those where the ownership is restricted to a particular profession licensed in that field, e.g. MDs. 15-11

Formation A corporation has the most formal filing and reporting requirements. Document must state the corporations name, purpose, number of shares issued, and address of the corporations headquarters. This document is known as the articles of Incorporation. 15-12

Preincorporation Activity: Liability of Promoters Such activities include arranging for necessary capital through a loan, recruiting personnel, leasing property, and arranging to have the business incorporated. The individual who performs these activities is known as a promoter. If the promoter makes a contract on behalf of a not-yetformed corporation, she may have some degree of personal liability to perform under the contract.

15-13 Choice of State of Incorporation Some significant advantages for large publicly held corporations may be gained by incorporating in Delaware; However, most corporations are better served by incorporating in the state where they are headquartered.

15-14 Initial Organizational Meeting Bylaws (rules by which corp. is run). Board of directors and officers. Issuance of shares. 15-15 Liability

Shareholders, directors, and officers of a corporation are insulated from personal liability in case the corporation runs up large debts or suffers some liability. This liability protection is often referred to as the corporate veil 15-16 Personal Guarantees

Banks, landlords, and other creditors are fully aware of the limited liability provided by the corporate veil. Thus, if a corporation is a start-up or has limited assets, these creditors will almost always require that the shareholders give a personal guarantee. 15-17 Piercing the Corporate Veil

Inadequate capitalization. Evidence of fraud or wrongdoing. Failing to follow corporate formalities. 15-18 Goldman v. Chapman and Region Associates, 44 A3d 938 (N.Y. 2007) One of the primary and legitimate purposes of incorporating is to limit or

eliminate the personal liability of corporate principals. The claim that the corporation was completely dominated by the owners, or conclusory assertions that the corporation acted as their alter ego, without more, will not suffice to support piercing the corporate veil. 15-19 Capitalization

Corporations have perhaps the widest range of options when considering how to finance their operations. They may be funded through debt or through the selling of equity in a variety of forms. 15-20 Debt

Corporations often borrow money from commercial lenders (such as banks) to fund day-to-day operations. For larger projects, corporations may also use more sophisticated forms of debt such as issuing bonds or debentures. 15-21 Equity

Corporations also sell equity to capitalize their operations. For modest amounts of funding, corporations may turn to private investors or groups of investors. Corporation will hire a registered brokerdealer to handle larger scale IPOs. 15-22 Public Offerings A very complex and time-consuming

process of converting the corporation from privately held to publicly held by engaging in an initial public offering (IPO). At that point, the corporation may raise equity by selling its shares to the general public and to financial institutions. 15-23 Taxation C corporations are considered a

separate legal, taxable entity from the owners for income tax purposes. Therefore, corporations pay tax on their earnings and then tax is paid again if corporate earnings are distributed to shareholders in the form of dividends (known as double taxation). 15-24

Taxation Subchapter S: Avoids double taxation. No more than 100 shareholders. Single class of stock. No non-resident alien shareholders. 15-25 STRUCTURE, MANAGEMENT, AND OPERATION

Corporations allocate power to shareholders, directors, and officers. 15-26 Shareholders Power to elect and remove directors. Power to veto fundamental changes to corporation, e.g. sale of all assets, mergers, issuing more capital stock, and issuing bonds.

Shareholders also must approve any changes in the structure of the corporation through amending the articles of incorporation or bylaws. 15-27 Board of Directors Sets strategy and policies of the corporation, including payment of dividends. Also has important oversight functions. Most planning initiatives that result in a change

to the corporation, such as an acquisition of another corporations assets or stock, are overseen by the board prior to submitting the plan to shareholders for approval. 15-28 Officers The corporations officers are appointed by, and may be removed by, the board of directors. The officers carry out the day-today operations of the corporation and

execute the strategy and mandates set out by the board of directors. 15-29 Fiduciary Duties of Officers and Directors Duty of care and the duty of loyalty Breaching these duties may result in personal liability for the officer or director.

This may be referred to as the business judgment rule. 15-30 Business Judgment Rule Most courts define good faith by requiring directors/officers to clear three hurdles to obtain protection of the rule: Rational belief

Best information No private conflicting interest 15-31 Duty of Care Negligence. Failure to act with diligence. Rubber stamp.

15-32 Duty of Loyalty The duty of loyalty is primarily focused on providing protection to shareholders in cases where a transaction occurs where the possibility of self-dealing is present. 15-33

Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) [T]he directors were entitled to rely upon their chairmans opinion of value and adequacy, provided that such opinion was reached on a sound basisthe issue is whether the directors informed themselves as to all information that was reasonably available to them.

15-34 Corporate Opportunity Doctrine (1) Did the corporation have a current interest or expected interest in the opportunity? (2) Is it fair to the corporations shareholders to allow another to usurp a certain interest? (3) Is the opportunity closely related to the corporations existing/prospective business

activities? 15-35 Breach of Fiduciary Duty Lawsuits by Shareholders Shareholders enforce their rights and fiduciary duties through the use of a lawsuit in the form of : shareholders derivative action, or Shareholders direct action.

15-36 Limiting Director Liability A corporate board typically has several measures in place designed to limit their liability: oversight committees to monitor executive management, and consulting/outside professional firms to

ensure validity of the information and data used by the board in their decision making. 15-37 Columbia/HCA Healthcare Corporation 239 F.3d 808 (6th Cir. 2001) Liability on the part of a director for breach of the duty of care for unconsidered action can form the basis for

liability. . .and the magnitude and duration of the alleged wrongdoing is relevant in determining whether the failure of the directors to act constitutes bad faith. 15-38 learning outcomes checklist 15 - 1 Identify the sources and level of law governing formation and internal corporate

matters. 15 - 2 Articulate the concept of the corporation as a legally independent person. 15 - 3 Recognize the liability associated with improper formation by a promoter. 15-39 learning outcomes checklist 15 - 4 Understand the concept of a corporate veil and identify circumstances under which a

court will pierce the veil and the impact on the principals. 15 - 5 Explain the primary methods for capitalizing a corporation. 15 - 6 Categorize corporate entities on the basis of how the income is taxed and understand the concept of flow-through taxation. 15-40 learning outcomes checklist

15 - 7 Describe the fundamental structure and roles for officers, directors and shareholders. The corporate form of entity and understand the functions of each role and how its governed. 15 - 8 Identify the major fiduciary duties owed by insiders of a corporation to its shareholders and give examples of each duty. 15 - 9 Apply the business judgment rule to an alleged breach of fiduciary duty by an insider. 15- 10 Distinguish between a shareholder derivative suit and

a direct action suit. 15-41