CHAPTER 30

1. CHAPTER 30 Corporations

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3. Quote of the Day “CORPORATION, n. An ingenious device for obtaining individual profit without individual responsibility.” Ambrose Bierce, American writer, “The Devil’s Dictionary”

4. Incorporation Process • The person who organizes a corporation is called a promoter. The promoter is personally liable on any contract signed before formation. • The corporation is not liable unless it adopts the contract after incorporation. The promoter is no longer liable if the other party agrees to a novation – a new contract. • Where to Incorporate? • In a state –either the home state of the business or a state which has favorable laws for corporations (often Delaware)

5. Incorporation Process • Charter’s Required Provisions • Name of corporation • Address and Registered Agent • Incorporator –person who signs the charter and delivers it to the Secretary of State for filing (perhaps the lawyer or the promoter) • Purpose –can be a broad statement, such as “to conduct lawful business” • Stock – number, par value and types (classes and series) offered

6. Stock • Stock can be: • Authorized and unissued • Authorized and issued or outstanding • Treasury stock (been issued, then bought back by company) • Par value - minimum issue price • Classes and series • Owners of preferred stock have preference on dividends and liquidation. • Common stock is last in line for any corporate payouts, including dividends and liquidation.

7. After Incorporation • Directors and officers are elected, unless all shareholders agree to not have a board of directors. • Minute book holds records of all meetings. • Bylaws set the rules for the corporation.

8. After Incorporation (cont'd) • Issuing Debt – corporations often need to borrow funds for start-up. • Bonds – long term debt secured by company assets. • Debentures – long term, unsecured debt. • Notes – short term, either secured or unsecured.

9. Death of a Corporation • May be voluntary (shareholders vote) or forced (by court order). • Piercing the Corporate Veil -- a court may hold shareholders liable for debt. • This happens in four circumstances: • Failure to observe formalities (such as holding meetings, keeping records) • Commingling of assets (using corporate funds to pay personal debts, etc.) • Inadequate capitalization (the corporation should obtain insurance against liability for torts) • Fraud (injured party may recover from the guilty party, even if the action was the corporation’s)

10. Termination • Terminating a corporation is a three step process: • Vote by a majority of the shareholders. • Filing Articles of Dissolution with the Secretary of State. • Winding up – paying debts and distributing assets.

11. The Role of Corporate Management (Managers vs. Shareholders) • Managers – want, first to keep their jobs and second, to build a strong company. • Managers have a fiduciary duty to act in the best interests of the shareholders. • Shareholders – want the price of stock to increase. • Stakeholders – want the business to grow and continue to use the stakeholders’ services.

12. The Business Judgment Rule (Resolving the Conflict) • Business Judgment Rule -- The manager has a duty of loyalty and a duty of care. • The manager must act without a conflict of interest, with the care of an ordinary prudent person and in the best interests of the company. • This rule allows directors to do their job without fear of excessive court intervention.

13. Duty of Loyalty • The duty of loyalty prohibits managers from making a decision that benefits them at the expense of the corporation. • Self-Dealing is a violation of the duty of loyalty. • See next slide for more on self-dealing. • Corporate Opportunitiy • Managers are in violation of the corporate opportunity doctrine if they compete against the corporation without its consent.

14. Self-Dealing • Business Self-Dealing – decisions that benefit another company associated with the manager. • Personal Self-Dealing --decisions that benefit the manager directly. • Self-dealing transactions may be acceptable if: • The disinterested members of the board of directors approve the transaction. • The disinterested shareholders approve it. • The transaction was fair to the corporation.

15. Duty of Care • The duty of care requires officers and directors to act in the best interests of the corporation and to use the same care that an ordinarily prudent person would in the management of her own needs. • Decisions must have a rational business purpose. • Decisions and actions are legal. • Managers must make informed decisions.

16. Takeovers • There are three ways to acquire control of a company: • Buy the company’s assets. • Merge with the company. • Buy stock from the shareholders. • Takeovers and tender offers are regulated: • Federal Regulation of Tender Offers: The Williams Act • State Regulation of Takeovers • Common Law of Takeovers

17. Prevention of Takeovers • Companies may try to prevent takeovers in many ways: • Transferring assets, re-distributing stock, re-structuring the board of directors, etc. • When establishing takeover defenses, shareholder welfare must be the board’s primary concern.

18. State Anti-Takeover Statutes • Most states have passed statutes to deter hostile takeovers: • Statutes that automatically impede hostile takeovers. • Statutes that authorize companies to fight off hostile takeovers.

19. Shareholders • Shareholders have neither the right nor the obligation to manage the day-to-day business of the enterprise; Directors have the right to manage the corporate business. • Shareholders’ Right to Information • Under the Model Act, shareholders with a proper purpose have the right to inspect and copy the corporation’s minute book, accounting records, and shareholder lists. • Shareholders’ Right to Vote • A corporation must have at least one class of stock with voting rights.

20. Shareholder Proposals • Under SEC rules, any shareholder who has, for one year, owned at least 1 percent of the company or $2,000 of stock can require that one proposal be placed in the company’s proxy statement to be voted on at the shareholder meeting. • Only a small percentage of these proposals are passed, but their presence may cause the directors to adopt the proposal’s statement anyway.

21. Shareholder Meetings • Annual meeting of shareholders are the norm for publicly traded companies. • Companies whose stock is not publicly traded may either hold an annual meeting or use written consent from their shareholders.

22. Officers and Directors • Election and Removal of Directors • Shareholders have the right to elect directors and also to remove them from office. • Compensation for Officers and Directors • Typically, directors also set their own compensation (unless the charter or bylaws provide otherwise).

23. Fundamental Corporate Changes • A corporation must seek shareholder approval before undergoing any of the following fundamental changes: • Mergers • Sales of Assets • Dissolution • Amendments to the Charter • Amendments to the Bylaws

24. Rights and Duties • If a corporation decides to undertake a fundamental change, the Model Act and many state laws require the company to buy back the stock of any shareholders who object to this decision. • Controlling shareholders have a fiduciary duty to the minority shareholders.

25. Sarbanes-Oxley Act • In response to corporate scandals, Congress passed the Sarbanes-Oxley Act in 2002. • Requires all publicly-traded companies to adopt effective financial controls. • CEOs and CFOs must personally certify their company’s financial statements. • A board’s audit committee must be independent. • No personal loans to directors or officers.

26. Sarbanes-Oxley Act (cont’d) • If a company has to restate its earnings, its CEO and CFO must reimburse the company for any bonus or profits they have received from selling company stock in the past year. • Each company must disclose if it has an ethics code and, if it does not, why not. • It is a felony to interfere with a federal fraud investigation. • Whistleblowing employees are protected. • A new Public Accounting Oversight Board has been established to oversee the auditing of public companies.

27. Enforcing Rights • Derivative Lawsuits • Brought by shareholders to remedy a wrong to the corporation. All proceeds of the litigation go to the corporation. • Direct Lawsuits • Shareholders are permitted to sue the corporation directly only if their own rights have been harmed.

28. “Entrepreneurs often become impatient with the legal technicalities required to form and maintain a corporation. However, these legalities can have a profound impact on the success of the business.”