CVP Flashcards
What is a Corporation?
It is a fictitious being, independent of its owners, that can conduct business in its own name.
NOTE: The other major type of business entity in the United States is a “partnership.”
The principal benefit of the corporate form is that shareholders are only liable for corporate debts to the extent of their investment in the corporation. However, that’s not the only benefit; there are several other important ones. What are they?
There are five major ones:
1. Taxation. If a corporation makes a profit and reinvests it instead of paying it to shareholders (as a “dividend”), it pays taxes instead of the shareholders. This is a benefit, because corporate tax rates are generally lower than the shareholders’ personal tax rate.
- Act as Legal Unit: A corporation can conduct business, because it has the power to contract, sue and be sued, and hold property.
- Centralized management: Control of corporate affairs is centralized in a board of directors and the officers they appoint. (This allows specialization; managers can be managers whether or not they have money to invest in the corporation, whereas investors need only provide money, not management skills.)
- Continuity of existence:
the corporation continues regardless of whether its ownership, management, and/or directors change. - Transferability of ownership: A corporation is alienable in “chunks” (i.e., shares). This isn’t true for “close” corporations, where transfer restrictions are written into the corporation’s bylaws.
What’s the difference between a “public corporation” and a “close corporation”?
A “public corporation” is a corporation with ownership consisting of widely separate stock holdings.
A “close corporation,” on the other hand, has few owners, as well as stock that isn’t traded on a national exchange or over-the-counter and that has restrictions of transferability. In fact, because they function more like a partnership than a corporation, close corporations are sometimes known as “incorporated partnerships.” Most states have statutes defining close corporations precisely.
WHY A CORPORATION WOULD WANT TO BE A “CLOSE” CORPORATION: Flexibility. Close corporation statutes give close corporations flexibility of governance not available to “regular” corporations (this is discussed in detail in the “close corporation” topic in this deck
People can conduct business without forming a corporation. What’s the principal reason they’d want to form a corporation?
Limited liability: What this means is that, when people conduct business by creating a corporation, if the corporation becomes insolvent, the individual shareholder will usually lose only the amount already paid for his stock (there are exceptions to this rule).
RATIONALE: Since shareholders have no right to participate in managing the corporation, they should not have unlimited liability for corporate obligations.
NOTE: OK, here are the major exceptions to the rule, where shareholders can be liable beyond their investment:
- A “close” corporation, whose shareholders sign personal guarantees on loans others make to the corporation, such that, if the corporation doesn’t pay, the guaranteeing shareholder must do so.
- A creditor has grounds for “piercing the corporate veil” and making shareholders liable for corporate debts.
Alfred Pennyworth is a 50% owner of Metropolis Crimefighters, Inc. Metropolis has two officers who serve as its directors and employees, Batman and Robin. They employ the “Green Eyeshade’ as their bookkeeper. Alfred is not a director or officer of ther corporation. Alfred is out shopping one day when he sees a nice, sedate station wagon, the Travel Queen Family Truckster, which he thinks would make a far more sensible company car than the Batmobile. He signs a lease for the Travel Queen on behalf of Metropolis. When Batman and Robin see the Travel Queen, Robin exclaims, “Holy Corporations, Batman! Is Metropolis Crimefighters bound by this lease?” Well – is it?
No. The issue here is the extent to which an owner of a corporation (i.e., a shareholder) may conduct corporate business. Here, that’s all Alred is; he’s neither a director nor an officer. The rule is that shareholders have no authority to conduct corporate business; the board of directors has such authority, which it may delegate to officers or subordinates. Thus, a shareholder cannot enter into a contract on the corporation’s behalf.
RELATED ISSUE: Say that Metropolis Crimefither has been a partnership instead of a corporation, and the Alfred was a partner. The rule is that each co-owner h the actual authority to conduct partnership business within the scope of the business, although the partners can modify this by delegating management responsibilities to certain partner(s) in the partnership agreement. Even if the partners do so, howevr, each partner has the apparent authority as to third parties to carry out partnership business, unless the third party has reason to suspect the actual authority has been exclusively delegated to someone else. Thus, had Metropolis Crimefighters been a partnership instead of a corporation, the partnership would have been bound by the lease (unless the Travel Queen dealership had reason to believe Alfred lacked actual authority to contract on the partnership’s behalf).
After their “excellent adventure,” Bill and Ted decide to pen up a travel agency, Bill & Ted’s Excellent Adventures. They decide the business should be operated as a corporation, so they draw up articles of incorporation and put them in the company safe-deposit box. They carry on the business as a corporation, putting an “Inc.” after the business name and keeping the company records and finances separate from their own. Is the travel agency a corporation?
No, it’s a partnership.
The principal difference in formation between a partnership and a corporation is filing. Creating a corporation requires that articles of incorporation be filed with the Secretary of State for the state in which the corporation is to be incorporated. A partnership doesn’t even require a written document, unless it’s a “limited partnership” (in which only the general partner can be liable for the partnership’s debts). Since the articles of incorporation here weren’t filed with the state, Bill and Ted have a partnership.
SIGNIFICANCE: The most important ramification of partnership v. corporation status is that Bill and Ted, as partners, are jointly and separately liable for the partnership’s debts and obligations; if the agency fails, their personal assets could be reached by a partnership creditor. In a corporation, unless it’s a close corporation or there are grounds for “piercing the corporate veil” and holding shareholders personally liable, shareholders are only liable for corporate debts and obligations to the extent of their investment in the corporation.
Curly owns shares in the Nyuck-Nyuck Wise Guys, a major league baseball team. Curly becomes disgusted with the whole business of baseball when the team makes a $50-mllion, five-year deal with a free agent, Mr. Potatohead. Without telling the other owners, Curly transfers his in the team to Shemp. As to whether Curly’s interest is transferable, does it matter whether the team is a partnership or a corporation?
yes; if it’s a partnership, Shemp isn’t an owner, and, if it’s a corporation, he probably is.
The rule on transferability of ownership for a corporation is that shares are freely transferable unless they are subject to a written restriction on transfer (note that shares in a close corporation must have restrictions on transfer).
For a partnership, unless the partnership contract provides otherwise, a partnership interest is onlly transferable with the remaining partner” approval; without it, the transferee cannot become a full partner. Keep in mind, however, that a partner can assign his interest in a partnership such that the assignee gets the partner’s profits from the partnership, but has no other involvement with the partnership; however, if the partnership dissolves, the assignee is entitled to the partner’ interest.
NOTE: “Close” corporations have restrictions on transfer similar to a partnership. Thus, for a corporation with very few owners, you’d look for restrictions on transfer.
Scrooge and Marley own a catering business. the Roast of Christmas Present, Ince. They each own 50% of the shares. Marley dies in a freak accident when one of the corporation’s employees. Bob Cratchit, drops a haunch of venison on him. Since Marley was a 50% owner of the corporation, does the corporation terminate along with him?
No. Corporate existence doesn’t depend in any way on its sharholders. As such, the death, withdrawal, or bankruptcy of anty shareholder doesn’t terminate the corporation.
COMPARE: A partnership, which dissolves when any partner dies, withdraws, or files for bankruptcy unless the partnership agreement provides otherwise. Uniform Partnership Act Sect. 31(1)(a). This means that, when any one of these occurs, the only authority left in the partners, as to the partnership business, is to wind up and liquidate the business.
Tarzan and Jane are 50% owners of the Me Tarzan, You Jane Charm School Inc. Last year, the harm school earned a $10,000 profit, which was spent on new etiquette videos. Do Tarzan and Jane each owe tax personally on their respective (50%) shares of the company’s profit?
No.
One of the benefits of conducting busness as a corporation is that a corporation is a taxable entity, such that, unless the corporation’s income is distributed to shareholders via a dividend, shareholders don’t pay tax on corporate income (and, conversely, can’t deduct corporate losses).
EXCEPTION: Small corporations may elect to be treated as a partnership for purposes of income and losses, such that income and losses are attributed to the shareholders regardless of whether income is distributed. This kind of corporation is called a “subchapter S corporation.”
RELATED ISSUE: A partnership is not a taxable entity. As a result, partnership profits and losses are attributed to the partners, who must report on their personal tax returns their share of partnership income and losses.
How do you go about forming a corporation?
You file for one. You follow the corporate statute in the stat in which you incorporate, which basically requires that the “incorporators” file a document called “araticles of incorporation” with a designated statae officer (usually the Secretary of State), and pay statutory filing fees.
NOTE: Althoughstate requirements vary, the Revised Model Business Corporation Act (RMBCA) is fairly typical, and that’s what we’ll use for a reference point in this topic.
NOTE Although filing the articles of incorporation completes the creation of the corporation, its structure isn’t complete until certain basic matters are taken care of, either at an organizational meeting of the board (if the board is named in the articles of incorporation) or at an organizational meeting of the incorporations (if the directors aren’t named in the articles). Steps taken at this meeting typically include naming directors (if they aren’t named in the articles), adopting bylaws, electing corporate officers, adopting a corporate seal (not the zoo kind) and stock certificate, authorizing shares to be issued to state people at a stated price, and designating a corporate bank.
How does a corporation decide in which state to incorporate?
It normally chooses either. 1. The state where its principal place of business is (or will be), or 2. Delaware (considered very permissive as to corporate flexibility, e.g., that size of the majority required for shareholder approval of important corporate decisions like mergers).
SIGNIFICANCE: The state of incorporation decides internal corporate governance issues like dividend declaration and shareholder vote requirements.
SIZE COUNTS! The state chosen for incorporation usually depends on the type of corporation you’re looking at.
- Closely held corporations: state of principal place of business. Rational: Cost (it’s cheaper to incorporate in-state) and flexibility (states generally give special flexibility to close corporations, even if they’re not permissive otherwise toward corporations).
- Public corporations: Delaware. Rational: Permissiveness (Delaware lets corporations accomplish major changes, like acquisitions and mergers, with no shareholder approval or a lower majority shareholder vote requirement than most states) and predictability (Delaware has a well-developed boy of corporate law, so corporations can judge how litigated issues, like takeovers, will be resolved.)
Forming a corporation requires, in essence, filing “articles of incorporation” with the Secretary of State in the state of incorporation. What do the “articles of incorporation” contain?
According to RMBCA Sec. 2.02(a), the articles must include:
1. The corporate name (which must indicate “corporateness,” e.g., “Inc.,” “Co.”; furthermore, the name cna’t be confusingly similar to that of any other in-state corporation),
2. the number and types of shares the corporation may issue (e.g., preferred, common),
3. address of the corporation’s registered office,
4. the name of the corporation’s registered agent at the registered office, and
5. each incorporator’s name and address.
MNEMONIC: A RAINS (Address; Registered Agent; Incorporators; Name; Share information).
NOTE: In addition, the articles may contain optional provisions, including:
1. the corporation’s purpose (it this isn’t included, the corporation may engage in “any lawful purpose,” RMBCA Sec.3.01(a),
- names and addresses of the initial board of directors
- “par value” of shares of stock,
- any provision that must or may appear in the corporation’s bylaws, and
- personal liability of shareholders for corporate debt to a stated extent and on stated conditions.
NOTE Only some state require a corporate purpose clause. In most of those that do, it’s enough to say that the corporation may engage in any lawful activity for which corporations may be organized (although the articles may limit the purpose). RMBCA Sec.2.02(b)(1984).
