Business Law: Corporate Formation

5/1/2023 1 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS L AW B USINESS L AW T EXT AND C ASES T EXT AND C ASES CHAPTERS 39: CORPORATE FORMATIONCHAPTERS 39: CORPORATE FORMATION © 2018 Cengage....

5/1/2023 1 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. B USINESS L AW B USINESS L AW T EXT AND C ASES T EXT AND C ASES CHAPTERS 39: CORPORATE FORMATIONCHAPTERS 39: CORPORATE FORMATION © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. IntroductionIntroduction  A corporation is a legal entity created and recognized by the law of a particular state.  A corporation can have one or more owners (called shareholders ).  Both individuals and other legal entities 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 are separate and apart from the shareholders who own it. 1 2 5/1/2023 2 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. IntroductionIntroduction  As a legal “person,” a corporation enjoys many, but not all, of the same rights and privileges under state and federal law that U.S. citizens enjoy.  Corporations possess the same right of access to the courts as citizens.  Corporations can sue or be sued. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate PersonnelCorporate Personnel  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 strategic policy decisions;  Hires corporate officers to run the company’s daily business operations. 3 4 5/1/2023 3 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate PersonnelCorporate Personnel  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 often change without affecting the continued existence of the corporation.  A shareholder can sue the corporation, and the corporation can sue a shareholder. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Limited Liability of ShareholdersLimited Liability of Shareholders  One of the key advantages of the corporate form of business is the limited liability of its owners.  Normally, corporate shareholders are not personally liable for the obligations of the corporation beyond the extent of their investments.  In certain very limited situations, however, a court may 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. 5 6 5/1/2023 4 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Earnings and TaxationCorporate Earnings and Taxation  When a corporation earns profits, it can either:  Pass them on to shareholders in the form of dividends  A dividend is a distribution of corporate profits to the corporation’s shareholders in proportion to the number of shares held.  Retain them as profits  Retained earnings are t he portion of a corporation’s profits that has not been paid out as dividends to shareholders. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Earnings and TaxationCorporate Earnings and Taxation  Whether a corporation retains its profits or passes them on to the shareholders as dividends, those profits are subject to income taxation at the corporate level by various levels of government.  A major disadvantage of the corporate form is that corporate profits can be subject to double taxation.  The company pays tax on its profits.  I f the profits are passed on to the shareholders as dividends, the shareholders must also pay income tax on them. 7 8 5/1/2023 5 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of CorporationsClassification of Corporations  Corporations can be classified in several ways.  The classification of a corporation normally depends on its:  Location  Purpose  Ownership characteristics © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Location Classification of Corporations: Location  Domestic corporation – In a given state, a corporation that is organized under the laws of that state.  Foreign corporation – In a given state, a corporation that does business in that state but is incorporated in another state.  Alien corporation – A corporation formed in another country ( e.g ., France), but doing business in the United States. 9 10 5/1/2023 6 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Purpose Classification of Corporations: Purpose  A public corporation is one owned by a federal, state, or municipal government .  This is not to be confused with a publicly-held corporation.  Examples: U.S. Postal Service, AMTRAK  Private corporations are created either wholly or in part for private benefit—that is, for profit.  Most corporations are private. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Purpose Classification of Corporations: Purpose  Nonprofit Corporations are formed for purposes other than for making a profit.  Examples: Private hospitals, educational institutions, charities, religious organizations  The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without exposing the individual members to personal liability. 11 12 5/1/2023 7 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Ownership Classification of Corporations: Ownership  While we are all familiar with various publicly-traded corporations, most corporate enterprises in the United States fall into the category of close corporations ( a/k/a a closely-held corporation) .  A close corporation is one whose shareholders are limited to a small group of persons, often family members.  Because the number of shareholders is so small, there is generally no trading market for the shares. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Ownership Classification of Corporations: Ownership  Management of a close corporation resembles that of a sole proprietorship or a partnership, in that control is held by a single shareholder or a tightly knit group of shareholders.  The firm must still meet all of the specific legal requirements for a corporation set forth in state statutes. 13 14 5/1/2023 8 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Ownership Classification of Corporations: Ownership  Because a close corporation generally has a small number of shareholders, 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 want to share ownership with.  To avoid this situation, a close corporation can restrict the transferability of shares to outside persons by spelling them out in a shareholder agreement. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Ownership: Texas Classification of Corporations: Ownership: Texas  In Texas , a close corporation must state in its certificate of formation that "this corporation is a close corporation."  A close corporation may be managed according to a shareholders' agreement instead of by a board of directors or bylaws.  As elsewhere, in Texas, shareholders in close corporations may agree to limit the conditions under which shares may be transferred or sold, and further agree how to apportion profits and losses. 15 16 5/1/2023 9 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification of Corporations: Ownership Classification of Corporations: Ownership  A Subchapter S Corporation is a corporation that has most of the attributes of a close corporation, including limited liability, but qualifies under the Internal Revenue Code to be taxed as a partnership.  Among the numerous requirements for Subchapter S corporation status, the following are the most important: 1. The corporation must be a domestic corporation. 2. The corporation must not be a member of an affiliated group of corporations. 3. The corporation must have no more than 100 shareholders. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Incorporation ProceduresIncorporation Procedures  Although each state has its own set of incorporation procedures, all incorporators generally follow several basic steps: 1. Select the state of incorporation. 2. Secure an appropriate corporate name. 3. Prepare the articles of incorporation. 4. File the articles of incorporation with the state. 17 18 5/1/2023 10 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Incorporation ProceduresIncorporation Procedures  The choice of a corporate name is subject to state approval to ensure against duplication or deception.  Most state statutes require a search to confirm that the chosen corporate name is available.  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. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Incorporation ProceduresIncorporation Procedures  The primary document needed to incorporate a business is the articles of incorporation .  This document is filed with the appropriate state official, usually the secretary of state, where a business is incorporated and contains basic information about the corporation. 19 20 5/1/2023 11 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. First Organizational Meeting to Adopt Bylaws First Organizational Meeting to Adopt Bylaws  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, then the incorporators hold the meeting to elect the directors and complete any other business necessary. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. First Organizational Meeting to Adopt Bylaws First Organizational Meeting to Adopt Bylaws  Usually, the most important function of the first meeting is the adoption of corporate bylaws .  These are the internal rules of management adopted by a corporation.  The bylaws typically describe such matters as:  Voting requirements for shareholders  The election of and methods for replacing the board of directors 21 22 5/1/2023 12 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate PowersCorporate Powers  When a corporation is created, the express and implied powers necessary to achieve its purpose also come into existence.  The express powers of a corporation are found in:  The state and federal constitutions  The statutory law of the state of incorporation  Its articles of incorporation, bylaws and corporate resolutions © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate PowersCorporate Powers  When a corporation is created, it also acquires certain implied powers .  A corporation has the implied power to perform all acts reasonably necessary to accomplish its corporate purposes, such as the implied power to:  Borrow and lend funds within certain limits  Extend credit to parties with whom it has contracts 23 24 5/1/2023 13 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Piercing the Corporate VeilPiercing the Corporate Veil  Piercing the corporate veil is the action of a court to disregard the corporate entity and hold the shareholders personally liable for certain corporate debts and obligations.  Generally, courts will only pierce the corporate veil:  When the corporate privilege is abused for personal benefit  When the corporate business is treated so carelessly that it is indistinguishable from that of a controlling shareholder © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Piercing the Corporate VeilPiercing the Corporate Veil  Factors that may cause the courts to pierce the corporate veil include: 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. 3. The corporation is formed to evade an existing legal obligation. 4. Statutory corporate formalities are not followed. 5. Personal and corporate interests are commingled. 25 26 5/1/2023 14 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Piercing the Corporate VeilPiercing the Corporate Veil  In a close corporation , the separate status of the corporate entity and the shareholders (often family members) must be carefully preserved.  The potential for corporate assets to be used for personal benefit is especially great in a close corporation.  Practices that invite trouble for a close corporation include:  The commingling of corporate and personal funds  The shareholders’ continuous personal use of corporate property © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Financing (Made Easy)Corporate Financing (Made Easy)  Corporations normally are financed by the issuance and sale of corporate securities .  “Corporate securities” may include shares of stock which constitute an ownership interest in a corporation.  Or the sale of bonds which represent a promise of repayment of debt by a corporation. 27 28 5/1/2023 15 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Financing (Made Easy)Corporate Financing (Made Easy)  Stock – An ownership (equity) interest in a corporation, measured in units of shares.  The two major types are: 1. Common stock 2. Preferred stock © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Financing (Made Easy)Corporate Financing (Made Easy)  A share of common stock gives the owner a proportionate interest in the corporation with regard to its control, earnings and net assets (upon dissolution).  Common stock is lowest in priority with respect to payment of dividends and distribution of the corporation’s assets on dissolution.  A corporation is not obligated to pay a holder of common stock a dividend.  Holders of common stock benefit when the market price of the stock increases. 29 30 5/1/2023 16 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Financing (Made Easy)Corporate Financing (Made Easy)  Preferred stock is a security that entitles the holder to preference in the payment of dividends and that has priority over common stock in the distribution of assets on the corporation’s dissolution.  Holders of preferred stock may or may not have the right to vote. © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Financing (Made Easy)Corporate Financing (Made Easy)  Bonds are debt securities , which represent the borrowing of funds.  Bonds normally have a designated maturity date—the date when the principal, or face amount, of the bond is returned to the bondholder.  Before the maturity date, bondholders receive fixed-dollar interest payments, usually semiannually.  For that reason, bonds are sometimes referred to as fixed- income securities. 31 32 5/1/2023 17 © 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Exhibit 39 - 1 How Do Stocks and Bonds Differ? Stocks 1. Stocks represent ownership. 2. Stocks (common) do not have a fixed dividend rate. 3. Stockholders can elect the board of directors, which controls the corporation. 4. Stocks do not have a maturity date. The corporation usually does not repay the stockholder. 5. All corporations issue or offer to sell stocks. This is the usual definition of a corporation. 6. Stockholders have a claim against the property and income of the corporation after all creditors’ claims have been met. Bonds 1. Bonds represent debt. 2. Interest on bonds must always be paid, whether or not any profit is earned. 3. Bondholders usually have no voice in or control over management of the corporation. 4. Bonds have a maturity date, when the corporation is to repay the bondholder the face value of the bond. 5. Corporations do not necessarily issue bonds. 6. Bondholders have a claim against the property and income of the corporation that must be met before the claims of stockholders. 33