chapter 24: corporate formation, financing, and termination

1

Chapter 1: Legal EthicsCHAPTER 24: CORPORATE FORMATION, FINANCING,

AND TERMINATION

2© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objectives1. What steps are involved in bringing a

corporation into existence?2. In what circumstances might a court

disregard the corporate entity (pierce the corporate veil) and hold the shareholders personally liable?

3. How are corporations financed?


Learning Objectives1. What are the steps of a merger, a

consolidation, or a share exchange process?

2. What are the two ways in which a corporation can be voluntarily dissolved?


• A corporation is a creature of statute, an artificial “person.”– Corporations can have one or more shareholders.– Owners can be natural persons or other

businesses.– Corporation substitutes itself for shareholders.

Corporate Nature and Classification


• Corporations are recognized as legal “persons” and enjoy virtually same rights and privileges under our Constitution as natural persons.



• Corporate Personnel.– Responsibility for overall management of company

rests with board of directors (elected by shareholders).

– Board of directors makes policy decisions and hires officers to run corporation on a daily basis.



• Corporate Personnel.– Shareholders can sue corporation and be sued by

corporation and bring suit for corporation in some instances.

• Constitutional Rights of Corporations.– Recognized as a legal “person” with protections

under the Bill of Rights, federal, and state statutes.



• Limited Liability of Shareholders.– One of the key advantages of corporations is the

limited liability of shareholders – In certain situations, the corporate “veil” of limited

liability can be pierced, holding the shareholders personally liable.



• Corporate Earnings and Taxation.– Corporate profits can either be kept as retained

earnings or passed on to the shareholders as dividends.

– Corporate Taxation: corporate taxes can be taxes twice, first to the corporation, then to the shareholders via dividends.



• Torts and Criminal Acts.– Corporation is liable for the torts committed by its

agents or officers within the course and scope of their employment under the doctrine of respondeat superior.



• Torts and Criminal Acts.– Corporation can be liable for criminal acts, but

only fined. – Responsible officers may go to prison.



• Classification of Corporations.– Domestic Corporation: does business in its state of

incorporation.– Foreign Corporation: from X state doing business

in Z state. – Alien Corporation: formed in another country

doing business in United States.



• Classification of Corporations.– Public and Private Corporations.– Nonprofit Corporations.



• Classification of Corporations.– Closely Held Corporations.• Management of Closely Held Corporations.• Transfer of Shares • Shareholder Agreement to Restrict Stock.



• Classification of Corporations.– Closely Held Corporations.• Misappropriation of Closely Held Corporation Funds.• CASE 24.1 RUBIN V. MURRAY (2011). How would you

determine reasonable compensation?



• Classification of Corporations.– “S” Corporations: avoids federal tax under IRS

Code “Subchapter S.” • Avoids federal “double taxation” of regular corporations

at the corporate level. Only dividends are taxed to the shareholders as personal income.



• Classification of Corporations.– “S” Corporations: avoids federal tax under IRS

Code “Subchapter S.” • IRS requirements: Corporation is

domestic, fewer than 100 shareholders, only one class of stock, no shareholder can be a non-resident alien.

– Professional Corporations.



Corporate Formation and Powers

• The process of incorporation generally involves two steps:– Promotional Activities; and – Incorporation Procedures.



• Promotional Activities.– Before corporation is formed, promoters are the

persons who take the preliminary steps of organizing the venture and attracting investors via subscription agreements.



• Promotional Activities.– Promoter’s Liability: Promoter is personally liable

for pre-incorporation contracts on behalf of the corporation, unless 3rd party agrees to hold future corporation liable.



• Incorporation Procedures.– Select State of Incorporation.– Secure the Corporate Name.• Must include words that disclose corporate status.• Cannot infringe on another’s trademark name.



• Incorporation Procedures.– Prepare the Articles of Incorporation: which deals

with shares, the registered agent and office, incorporators, duration and purpose, and internal organization. –File the articles with the state.



• First Organizational Meeting.– Adopt Bylaws:• After the corporation is “chartered” (created) it can do

business.• At meeting, shareholders should approve the bylaws,

elect directors, hire officers and ratify pre-incorporation contracts and activities.



• Improper Incorporation.– De Jure: substantial statutory requirements

are met; cannot be attacked by state or 3rd parties.

– De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law; can only be attacked by state.



• Improper Incorporation.–Corporation by Estoppel: If it acts like a

corporation, it cannot avoid liability by claiming that no corporation exists.



• Corporate Powers.– Express Powers.• Found in the corporation’s articles of incorporation, the

laws of the state of incorporation, and in the state and federal corporations.• Corporate by-laws may also grant or limit a

corporation’s express powers.



• Corporate Powers.– Implied Powers.• To perform all acts reasonably necessary to accomplish

its corporate purposes.• A corporate officer can bind corporation in contract in

matters connected with the ordinary business affairs of the enterprise.



• Corporate Powers.– Ultra Vires Doctrine.• Corporate acts beyond the express or implied powers

of the corporation (by statute of articles of incorporation).• Corporate articles of incorporations now adopt very

broad purposes to prevent lawsuits against the corporation.


• Piercing the Corporate Veil– In certain situations, courts will “pierce the

corporate veil” and hold shareholders personally liable in the interests of justice and fairness.



• Factors That Lead Courts Use to Pierce the Veil.– A party is tricked into dealing with a corporation

rather than the individual. – Corporation is set up never to make a profit or

remain insolvent or is under capitalized.



• Factors That Lead Courts Use to Pierce the Veil.– Corporation is formed to evade an existing legal

obligation.– Statutory formalities are not followed. – Commingling of personal and corporate interests

or assets.



• Piercing the Corporate Veil: A Potential Problem for Closely Held Corporations.– CASE 24.2 SCHULTZ V. GENERAL ELECTRIC

HEALTHCARE FINANCIAL SERVICES (2010). Why was Schultz personally liable?



Corporate FinancingBonds vs. StocksDebt Ownership/equity

Fixed ROI Dividends (variable)

No votes Vote for Management

Optional Required

Priority over stock Paid last


Corporate Financing Stocks: Issued by business firms and

government at all levels.–Normally have a maturity date – when

principal is returned to investor.–Sometimes referred to as fixed-income

securities, because bondholders receive fixed-dollar interest payments.–Bond indenture: lending agreement.


Corporate Financing Common Stock: represents true

ownership of a corporation. –Provides pro-rata (proportional) ownership

interest reflected in voting, control, earnings and assets.– Investors who assume a residual financing

position (whatever is left may go to dividends to shareholders).


Corporate Financing Preferred Stock: has preferences over

common stock.–Cumulative Preferred.–Participating Preferred.–Convertible Preferred.–Redeemable or Callable Preferred.


Corporate Financing• Venture Capital: start-up businesses and

high-risk enterprises need start-up and expansion capital. The start-up typically gives a share of its stock.

• Private Equity Capital: obtain capital from wealthy investors. Ultimately, the company may sell shares in an IPO.


• Merger: combination of two or more corporations (A & B), after which only one company remains (A), with all of B’s rights and obligations.

Merger and Acquisitions


• Consolidation: when two or more corporations (A & B) combine and a new corporation (C) is created, with A and B ceasing to exist.

Merger and Acquisitions


Merger and Acquisitions Share Exchange: some or all the

shares of one corporation are exchanged for some or all of the shares of another corporation.

Procedures.–Board of Directors of each corporation

involved must approve the merger plan.


Merger and Acquisitions Procedures (cont’d): –Majority of shareholders of each

corporation must approve.–Then, documents are filed with

Secretary of State who issues a certificate of merger.


Merger and Acquisitions Short-Form Mergers. –For “Parent-Subsidiary” Merger.–No approval of shareholders needed.–Parent must own at least 90% of each

class of stock of the subsidiary corporation.–Board of parent corporation approves

and new articles filed.


Merger and Acquisitions Shareholder Approval.

Merger, consolidation, sale of most of corporation’s assets not in the ordinary course of business, adverse amendments to the articles of incorporation.


Merger and Acquisitions Appraisal Rights. Shareholder has the

right to be “bought out” of his/her shares.–Procedures: corporation notifies

shareholders, who can demand fair market value appraisal.–Appraisal Rights and Shareholders

Status: dissenting shareholder looses voting rights.


Mergers and Acquisitions Purchase of Assets.–The acquiring corporation extends its

ownership and control over the physical assets of another company.• Acquiring corporation shareholders do not

need to approve.–Sale of Corporate Assets.•Must have approval of directors and

shareholders.


Mergers and Acquisitions Purchase of Assets.–Successor Liability in Purchases of

Assets.• Generally, the purchasing corporation is

not automatically responsible for the liabilities of the selling company. • In the following situations, the purchasing

company will be held to have assumed both the assets and liabilities of the selling company.


Mergers and Acquisitions Purchase of Assets.–Successor Liability (cont’d). Purchasing

company assumes both liabilities and assets if:• Acquiring corporation impliedly or expressly

assumes the liabilities.• Sale amounts to what is really a merger or

consolidation.• Purchaser continues the seller’s business and

retains the same personnel.


Mergers and Acquisitions Purchase of Assets.–Successor Liability (cont’d). Purchasing

company assumes both liabilities and assets if:• Sale is fraudulently executed to escape liability.• CASE 24.3 American Standard, Inc. v. OakFabco,

Inc. (2010). Was the purchasing company responsible for liabilities after closing?


Mergers and Acquisitions Purchase of Stock and Tender Offers.–Purchase of Stock: Common alternative

to merger or consolidation is the purchase of a controlling interest (up to 51%) of a “target” corporation’s stock (called a “takeover”) giving the purchaser corporation controlling interest in the target.


Mergers and Acquisitions Purchase of Stock and Tender Offers.–Tender Offers.• A publicly advertised offer addressed to all

shareholders of the target is called a tender offer.• Tender offer is usually higher than market value

per share but conditioned on the acquisition of a certain % of shares–Can be in exchange for aggressor's stock.–The SEC strictly regulates tender offers.


Mergers and Acquisitions Purchase of Stock and Tender Offers.–Tender Offers. Responses:• Directors may view the offer as favorable or

unfavorable. If favorable, then a recommendation is made to the shareholders.• If unfavorable, directors may make a self-

tender to buy stock, launch a media campaign, or issue additional stock.


Termination• Voluntary Dissolution.– Shareholders can initiate dissolution or the board

can initiate by submitting a proposal to the shareholders.


Termination• Involuntary Dissolution.– State can dissolve a corporation for failure to

comply with state regulations.– Court can dissolve a corporation if there is a

deadlock, the acts of directors are fraudulent or illegal.


Termination• Involuntary Dissolution (cont’d).– Court can dissolve if assets are being misapplied or

wasted.– Shareholders are deadlocked and failed to resolve.


Termination Winding Up.–Voluntary Dissolution: Board liquidates and

acts as trustees of assets. Court will appoint a receiver if board refuses; or creditors want a receiver. –Involuntary Dissolution: court appoints

receiver.–Liquidated assets first to creditors, then

shareholders.

chapter 24: corporate formation, financing, and termination

Documents

classroom use

corporate nature

certain product

cengage learning

passwordprotected website

corporate personnel

corporate formation

corporate veil