THE CORPORATE FORM

May 30, 2007

The Nature of Corporations

The basic underpinnings of corporations are the same as those of unincorporated forms of businesses: Agency law: authority and apparent authority Fiduciary principles: obligations of constituencies to one another Contract law: nexus of various contractual relationships

CORPORATIONS ARE CREATURES OF STATUTE AND ONE MODEL SAYS THEY ARE A NEXUS OF CONTRACTS

They have a contract with:

The state of incorporation, which sets the basic parameters of corporate existence Various other constituencies who have contract rights or legally enforceable expectations vis--vis the corporation (i.e., shareholders, directors, officers, employees, suppliers, agents)

Who are the Corporate Constituencies?

Shareholders Advisors Board of Directors Customers Creditors

ABC, Inc.
Suppliers Management (CEO, COO, CFO, Secretary, VPs, etc.)

Employees

Subsidiary

Other Constituencies, The Community

When a corporate lawyer is engaged, which constituent is his/her client?

The Chief Executive Officer? The General Counsel? The Chief Financial Officer? The Corporation? The Shareholders? The Board of Directors?

When a corporation engages a lawyer, the corporation is the client

This frequently leads to conflicts of both an ethical nature and a personal nature.

A Corporation is a Separate Entity

A corporation is a statutory entity with its own separate legal status. It is legally distinct from its shareholders, directors, officers, and other constituencies. This is called the corporations entity status. Note: Remember our study of this concept (versus aggregate status) on partnerships?

Corporate Characteristics
Limited Liability
Corporation shareholders are not personally liable for corporate obligations Corporation managers, i.e., officers and directors, are not personally liable for corporate obligations

Corporate Characteristics
Free Transferability of Ownership Interests
Corporation stock ownership is freely transferable Transferability may be limited in certain circumstances Partnership interests are not, generally, freely transferable

Corporate Characteristics
Centralized Management
Corporations are managed under direction and authority of boards of directors Officers manage dayby-day and report to the board Shareholders, not management, are ultimate authority

Corporate Characteristics
Entity Status
A corporation is a legal entity that has rights and powers in its own legal capacity Owners, i.e., shareholders do not act in the corporate capacity of the corporation

Corporate Characteristics
Perpetual Existence
Corporations usually have perpetual existence (except for special purpose vehiclesSPVsor special purpose entitiesSPEs formed solely for unique transactions of a limited duration

Corporate Characteristics
Double Income Taxation
Corporations pay income tax on income of the corporate entity and shareholders pay income tax on dividends they receive from the corporation

DISTINCTIONS BETWEEN CHARACTERISTICS OF CORPORATIONS AND PARTNERSHIPS (See Comparison Chart on TWEN)

Distinctions from Partnerships

Limited Liability
Corporations: Shareholders not personally liable for corporation liabilities Directors and officers not personally liable for corporation liabilities Partnerships: Partners personally liable for partnership liabilities Manager-partners personally liable for partnership liabilities

Distinctions from Partnerships

Transferability of Interests
Corporations: Ownership of shares is freely transferable, except in certain circumstances (e.g., restricted securities, shareholder agreements) Partnerships: Partnership interests are generally not freely transferable without partners consent

Distinctions from Partnerships

Centralization of Management
Corporations: Partnerships: The board of directors Absent agreement to oversees the affairs of the contrary, the corporation partnerships are managed by the Officers are day-topartners collectively day managers and and the majority vote report to the board dictates Shareholders are the ultimate governing authority

Distinctions from Partnerships

Entity Status
Corporations: Partnerships: A corporation is a Although modern legal entity that acts partnerships are in its own legal entities, an act of a capacity, e.g., it may general partner of a hold property, dispose partnership is an act of property, and sue of the partnership and and be sued in its vice versa because of own name personal liability of partners

Distinctions from Partnerships

Duration of Existence
Corporations: A corporation usually has perpetual existence Partnerships: Partnerships effectively dissolve on exit of a partner unless 2 or more continue without liquidation or settlement of the business

Distinctions from Partnerships

Income Taxation
Corporations: Double taxation of corporate income and shareholder dividend income Partnerships: Pass-through taxation to partners of partnership income

Factors in Selecting Business Form

Considerations of
Internal efficiency Operational cost Organizational convenience Limited liability and responsibility of owners for debt and other types of liabilities Minimization of income tax liability

Organizing a Corporation
Choice of state of incorporation Close corporations almost always incorporate in the state of their principal place of business because of:
1. Convenience 2. Doing business and franchise taxes may overlap and tax savings may result 3. Local advisers (lawyers, accountants, etc.) are familiar with local and state laws 4. Intrastate securities offering exemption 5. No foreign corporation registration

Organizing a Corporation
Choice of state of incorporation Publicly held corporations have other considerations and may or may not incorporate in the state of their PPB. Convenience, immaterial tax savings, and local experts are not as important to them.

Organizing a Corporation
Choice of state of incorporation Delaware has become, since the 1940s, a preferred incorporation forum because of advantageous management and corporate statutory law. There is also an abundant body of corporate case law. More than half a million business entities are incorporated in Delaware including more than 50% of all U.S. publiclytraded companies and 58% of the Fortune 500.

Organizing a Corporation Process

Name reservation. 10-2B-4.01 to -4.03 Choose 1 or more incorporator. 10-2B-2.01 Select, clear, and reserve corporate name. 102B-4.01, -4.02 File articles of incorporation. 10-2B-2.03

Organizing a Corporation Process

Question: What is the legal act of incorporation? The filing of articles of incorporation. See 10-2B-2.03(a).

Organizing a Corporation Process

In organizing a corporation, the fundamental documents include, at a minimum: Articles of Incorporation Bylaws Minutes of an organizational meeting of (1) the incorporators, (2) the subscribers for stock or stockholders, or (3) subsequent to incorporation, the initial directors named in the articles of incorporation

Organizing a Corporation Process Articles of incorporation10-2B-2.02 The mandatory contents of articles of incorporation are dictated by statute, but additional optional provisions may be added. Need capital structure; agent for service-of-process in Alabama; office street address; initial director(s); corporate purpose(s).

Alabama Secretary of State Form Articles STATE OF ALABAMA DOMESTIC FOR-PROFIT CORPORATION ARTICLES OF INCORPORATION GUIDELINES PURSUANT TO THE PROVISIONS OF THE ALABAMA BUSINESS CORPORATION ACT, THE UNDERSIGNED HEREBY ADOPTS THE FOLLOWING ARTICLES OF INCORPORATION.

Alabama Secretary of State Form Articles

Article I The name of the corporation: Article II The duration of the corporation is perpetual unless otherwise stated. Article III The corporation has been organized for the following purpose(s): Article IV The number of shares which the corporation shall have the authority to issue is___________.

Alabama Secretary of State Form Articles Article V The street address (NO PO BOX) of the registered office: _______________________ ________________________________________ __________ and the name of the registered agent at that office: ______________________________________ _______. Article VI The name(s) and address(es) of the Director(s): Article VII The name(s) and address(es) of the Incorporator(s):

Alabama Secretary of State Form Articles

Any provision that is not inconsistent with the law for the regulation of the internal affairs of the corporation or for the restriction of the transfer of shares may be added. IN WITNESS THEREOF, the undersigned incorporator executed these Articles of Incorporation on this the ____ day of ___________, 20__. (Signature)

Organizing a Corporation Process

BylawsSection 10-2B-2.06

(a) The board of directors of a corporation shall adopt initial bylaws for the corporation unless the right to adopt the initial bylaws is reserved to the shareholders in the articles of incorporation. (b) The bylaws of a corporation may contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with law or the articles of incorporation.

Organizing a Corporation Process

The Bylaws are, essentially, the rules of operating the corporation. However, any provision of the Bylaws that is inconsistent with the Alabama Business Corporations Act or the articles of incorporation is trumped by the ABCA or articles.

Organizing a Corporation Process

An organizational meeting of the initial directors typically includes the following business items:
Election of a chairman of the board Election of officers Adoption of Bylaws Fixing number of directors (unless fixed in the articles of incorporation)

Organizing a Corporation Process

An organizational meeting of the initial directors typically includes the following business items (continued):
Authorization of issuance of capital stock Approval of bond Approval of corporate seal Authorization of corporate bank accounts Other business

Organizing a Corporation Process

Consequences of defective incorporation may be harsh. In Cantor v. Sunshine Greenery, Inc. (NJ Sup. Ct. 1979), what was the effect to the corporate organizers that the corporation was held to be a de facto corporation?

Organizing a Corporation Process

In the event of the absence of a de facto or de jure corporation, a defectively formed corporation is not a corporation. The default form of business organization would be a sole proprietorship or general partnership, resulting in personal liability for the owners.

De Jure Corporation
Were talking de jure (Latin: by law or by right), not du jour (French: du, of the + jour, day)

Organizing a Corporation Process A de jure corporation is one that exists as a matter of law by reason of full compliance by incorporators with the requirements of law. A de facto corporation is one that is deemed to exist under color of law, despite omission of an essential element of organization, based on a good faith effort to comply.

Organizing a Corporation Process

A fundamental condition precedent to protection of the owners afforded by the de facto incorporation doctrine is a good faith attempt to comply with the incorporation statute.

Organizing a Corporation Process

In Cantor, did the organizers evidence a good faith attempt to comply? The act of executing the articles, the bona fide effort to file them, and dealings with plaintiffs in the name of the corporation demonstrated the requisite good faith.

Organizing a Corporation Process

Incorporation by estoppel. Based on the theory that those who hold forth an enterprise on the basis that it is a corporation or those who deal with an enterprise as if it were a corporation, knowing otherwise, should, as a matter of equity, be preventedestopped from treating it as anything else.

Organizing a Corporation Process Blacks Law Dictionary (8th ed. 2004) defines corporation by estoppel as a business that is deemed, by operation of law, to be a corporation because a third party dealt with the business as if it were a corporation, thus preventing the third party from holding a shareholder or officer of the corporation individually liable. The definition can cut both ways.

Liability for Preincorporation Transactions

The general rule is that when a promoter makes a contract for the benefit of a corporation that has not yet been organized, the promoter is personally liable on the contract and remains liable after the corporation is organized. Further, the corporation is not liable for the contract after the corporation is organized due to a lack of authority unless the corporation ratifies or adopts the contract or there is a novation of the contract.

Liability for Preincorporation Transactions

The exception to the general rule that a promoter is liable for preincorporation contracts is that if the party who contracts with the promoter knew that the corporation was not in existence at the time of the contract, and nevertheless agreed to look solely to the corporation for performance, the promoter is not deemed to be a party to the contract and is not liable for it.

Ala. Code 10-2B-2.04

Any person purporting to act as or on behalf of a corporation, knowing there was no incorporation under this chapter, is liable for all liabilities created by so acting.
This is a MBCA provision and is consistent with the general rule. However, before the adoption of this statute in 1994, the effect of preincorporation transactions Alabama was left to case-by-case development in the courts.

Organizing a Corporation Process

10-2B-2.04 does not preclude imposition of liability under the doctrine of de facto corporateness or equitable principles of estoppel. These remedies are equitable in nature and may correct, supplement, or supercede the common and statute law as applied to particular circumstances.

Organizing a Corporation Process The cases which typically do not fall within these circumstances are those where promoters have incurred obligations in the process of incorporation or where partners who seek to convert a partnership to a corporation incur liability obligations during that process. The key in imposing liability under 10-2B-2.04 is that they knew "there was no incorporation."

Organizing a Corporation Process

Knowledge of the non-existence of a corporation de jure is a condition to the application of both 10-2B2.04 and the equitable doctrine of incorporation by estoppel.

Organizing a Corporation

Capital Structure Common Stock: Equity interest representing ownership in a corporation. Generally carries the right to vote for directors and certain other matters. Dividends on net profits. The last to get paid after creditors (residual interest).

Organizing a Corporation Process

Capital Structure Debt: Trade debt Bank Debt Bonds and Debentures

Organizing a Corporation

Capital Structure Debt: Trade debt is money owed for goods and services provided to the corporation. Balance sheet line item is Accounts Payable.

Organizing a Corporation

Capital Structure Debt: Bank debt is principal and interest owed to banks and other financial institution lenders. Balance sheet line item is Loans Payable.

Organizing a Corporation

Capital Structure Debt: Bonds and debentures are principal and interest owed to lenders other than banks and other financial institution lenders. Balance sheet line item is Loans Payable or a more specific description.

Organizing a Corporation

Capital Structure Preferred Stock: A hybrid of an equity security and the senior status of debt instruments. Dividend (cumulative), liquidation, and other preferential elements are inherent to these securities.

Organizing a Corporation

Capital Structure Derivative SecuritiesMore exotic securities that are derived from common types of securities. CMOs, trust preferred securities, inverse floaters tied to interest rates are examples.

Ultra Vires Doctrine

SCOPE OF CORPORATE POWERS

Activities outside the scope of corporate powers

Ultra Vires Doctrine

Under traditional theory, a corporation is regarded as a fictitious person endowed with only those powers as are stated in its charter. Activities outside those stated powers are ultra vires, or beyond the corporations powers, and unenforceable against the corporation due to a lack of contractual mutuality.

Ultra Vires Doctrine

A corporation could raise ultra vires as defense in limited circumstances, but not in cases of:
Corporate torts Criminal liability Reversal of completed transactions

Ultra Vires Doctrine

Over time, courts implied corporate powers to undermine the doctrine and bind them in transactions that were incidental or auxiliary to their explicit powers.

Ultra Vires Doctrine

Modern statutes have effectively abolished the doctrine with general purpose authorization of powers.

Ultra Vires Doctrine

Purposes. Corporations may be organized under this chapter for any lawful purpose or purposes.

Ala. Code section 10-2B-3.01

Ultra Vires Doctrine

In drafting of articles of incorporation, it is now commonplace to state the purpose of the corporation substantially as follows:

The corporation shall have power to engage in any lawful business.

Money Isnt Everything

The famous case of Dodge v. Ford Motor Co. (1919)

What are the purposes of a corporation?

Maximize shareholder wealth? Improve humankind and society through charitable giving and service? Enhance the lifestyle of its employees, especially the CEO and other executives? Provide expert advice to government? Improve the effectiveness of government through legislative affairs (i.e., lobbying), political action committees?

What are the purposes of a corporation?

OR

Is it all of these things and more? Do the shareholders have any say in the utilization and expenditure of the corporations financial and other resources? Besides, its their money, isnt it? What is a proper balance and allocation of corporate resources?

Dodge v. Ford Motor Co. (1919)

Facts of the Case
What does this case have to do with the ultra vires doctrine or the purposes of a corporation?

Dodge v. Ford Motor Co.

Henry Ford 58% and board control

Ford Motor Co.

10%

Ford Bro.

Ford Bro.

32%

Others

Dodge v. Ford Motor Co.

Ford had a surplus excess capital above assets (-) liabilitiesof $112MM, including $52.5MM in cash and $1.3MM in muni bonds. Ford had been paying a regular annual dividend of $1.2MM.

Henry Ford 1863-1947

Dodge v. Ford Motor Co.

My ambition is to employ still more men; to spread the benefits of this industrial system to the greatest possible number; to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business.

Henry Ford 1863-1947

Open PDF The New York Times 1/14/1914 article on Ford

Dodge v. Ford Motor Co.

Lets revisit the corporate structure and the constituencies served by the corporation. Who would you say is the most important of these constituencies?
Henry Ford 1863-1947

Shareholders Advisors Board of Directors Customers Creditors

ABC, Inc.
Suppliers Management (CEO, COO, CFO, Secretary, VPs, etc.)

Employees

Subsidiary

Other Constituencies, The Community

Dodge v. Ford Motor Co.

Why were Henry Fords social concerns not persuasive to the court?

Why should a court interfere with the directors discretion not to declare dividends?

Henry Ford 1863-1947

Dodge v. Ford Motor Co.

Intel, a corporate giant, and many other large corporations do not pay regular corporate dividends. Neither did Microsoft until 2003.
Henry Ford 1863-1947

Dodge v. Ford Motor Co.

This case is one of the few reported cases where a court interfered with a courts decision not to declare dividends.
Henry Ford 1863-1947

Dodge v. Ford Motor Co.

10-2B-6.40 sets forth the narrow limitations on a boards discretion to declare and pay dividends if, as, and when it deems proper.
Henry Ford 1863-1947

Dodge v. Ford Motor Co.

Finally, note that approximately 30 states have enacted stakeholder or other constituency statutes that authorize boards to consider interests other than shareholder wealth maximization in making corporate decisions.

Henry Ford 1863-1947

Dodge v. Ford Motor Co.

10-2B-304(a) provides:

Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.

Henry Ford 1863-1947

Dodge v. Ford Motor Co. The precise issue presented in Dodge is unlikely to arise again because of the adoption by Congress of an accumulated earnings tax on corporations.

(Note: this tax does not apply to LLCs, presenting a possible choice-of-entity consideration.)

Henry Ford 1863-1947

Dodge v. Ford Motor Co. From 2003 through 2008, the IRS imposes an additional "accumulated earnings" tax of 15 percent on earnings a corporation accumulates above $250,000.

Henry Ford 1863-1947

Dodge v. Ford Motor Co. Although this tax is easy to avoidfor reasons we wont discuss herethis tax is designed to dissuade corporations from accumulating earnings just to avoid paying taxable dividends. MR. MCCLAIN, OUR ACCOUNTANT, IS THIS STILL RIGHT?
Henry Ford 1863-1947

Dodge v. Ford Motor Co.

Late in the course, we will see these stakeholder statutes come into play when we look at Delaware cases dealing with antitakeover measures by corporations and their ability to take nonshareholder constituencies into account.

Henry Ford 1863-1947

END OF SESSION SLIDES