Nature of the Corporation
Corporation – distinct business entity —independent from its owners
Ø Juridical entity
o Created by law
o Legal artifice
Ø State statutes which govern creation and characteristics of corps
o Enabling statutes – without wouldn’t be able to exist
Ø Entity principle – the corp. is a legal person separate and apart from its shareholders and directors
o Entity is who sues and can be sued
How does it start existing?
Ø Articles of Corporation are filed with the Secretary of State
Ø Look at Model Bus Act §2.03, Del Act §141
o Can only be managed by Board of Directors
o Del. §106 – upon filing
o As soon as file, you took into juridical entity – no longer individuals
Internal Affairs Doctrine – permits the parties through articles of incorporation to fix the law that applies
Ø State courts bound to accept laws of state where incorporation
Federal Securities Law – concerned about proper disclosure to investors about what is going on in corporation
Intra-corporate conflict – Shareholders delegate all control to Board of Directors
Ø Investors are passive
o Having separate investors and management allows ——- It can generate large amounts of capital and building larger enterprises
o Breeding grounds for intra-corporate conflict
§ They both Share – maximization of the profitability of the enterprise
§ Each have own agenda
§ Business judgment rule —- protects managers
§ Can let shareholders approve of fundamental changes in corp. – protect investors
· Organizational change – merger
Investors are only liable for personal investment
Ø Dividends – distribution of profits of the corporation at the discretion of the board of directors
Board of Directors delegate responsibilities to officers
Ø Board makes decisions
Ø Officers carry out those decisions
Ø Shareholders have no power to govern corp.
Taxation – double on distributed earning
Ø Entity vs. flow through treatment
o Corp. vs. partnership
o Examples
§ Partnership A&B&C – income flows through to partners and the partners pays tax on the income or losses(no tax paid by partnership)
§ Corp. ABC – corp. pays tax on $300, corp. declares dividend of $100 – shareholders are then taxed on that $100 dividend (double taxation)
§ Corp ABC – no dividends – corp. pays tax on $300, shareholders then pays no tax on earnings unless (dividends or they sell capital gains)
§ Corp ABC losses $300, corporation only can deduct the loss (unless you sell your share)
§ Partnership losses $300, partners can deduct that loss
Key Characteristics of Corporations
Ø Legal entity
Ø Limited liability (liable for amount of investment only)
Ø Free transferability of shares
Ø Perpetual existence
Ø Centralized management
Ø Entity is taxed (double taxation)
Promoters and the Corporate Entity
Promoter – a person who identifies a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people.
Ø Owes a fiduciary obligation to the corporation
o Guy with idea and without money, finds people with money, to start business and makes money – pre-incorporation
Promoters are prohibited from secretly pursuing personal gain
A promoter is a person who takes the initiative in founding and organizing a business.
Promoter’s liabilities will arise under one of three theories
breach of fiduciary duty
if made profits on sale of property to the corp. – may be liable for the profit or may be forced to rescind the sale
however, if disclosed all material facts to the transaction – no breach
if promoters purchase all stock with intent to keep themselves, then subsequently sell to outsiders – cannot be liable for breach (no one to keep secret from)
fraud or misrepresentation
basis can either be common law fraud (material representation, reliance, damages) or a state or federal security statute
obtaining unpaid stock
Who is liable on pre-incorporation contracts?
Ø The promoter (personally liable)
Personal liability of the promoter
Ø Pre-incorporation contracts
Ø if he personally signs
Ø promoter signs in corp.’s name, but knows corp. is not in existence and contracting party does not know that the corp. is not formed
o however, if the corp. adopts or ratifies the contract — the corp. is liable
§ there must be a novation of release to take the liability of the promoter away
o if other party urges promoter to use corp. name – also promoter is not liable
Ø corp. formed, but does not adopt the contract
Ø if secretly profits before the corp. is formed — fiduciary
Liability of the corporation
Ø no adoption, no liability
Ø if adopt, bound
o express — by resolution of the Board
o implied — receives benefits
If corp. later formed, can corp. enforce contract?
Ø Ratify the contract – yes (adopt the contract)
o Promoter can still be personally liable —– the only way to extinguish his liability is a novation or a release
Ø It could also become a third party beneficiary of the contract
Ø Promoter may also have right of indemnification
General rule – No liability for corporation before incorporation (the promoter is held liable during this time)
Can initial agent (promoter) avoid liability?
Ø Escape clause in contract – if no corp. is formed then not liable
Ø After formation — can escape by novation or release
If corp. is never formed, who is liable?
Ø Promoter
Ø However, if have the escape clause, go after investors (not shareholders yet – so no limited liability – general partners – joint and several liability to the extent to their personal liability) could be treated as partnership
If representing investors, what do you do?
Ø You make sure you incorporate fast and carefully.
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Defective Incorporation
De facto corporation – as long as there is a colorable attempt to incorporate, the court will hold that the entity is a de facto corp.
Ø therefore, the shareholders are not personally liable to the creditors
Ø MBC abolishes de facto corp.
Corporation by Estoppel – The Plaintiff must deal with the business as a corporation. Once they have done this, they are estopped from denying the corporation’s existence
Ø Only applies to contract cases, and not tort cases
Southern Gulf Marine Co. No 9 v. Camcraft
Ø Plaintiff (South Gulf) entered into contract with Camcraft to furnish a ship (vessel construction contract)
o Letter of Agreement was entered into on December 6, 1978 (letter of intent)
o Under the contract Southern Gulf was suppose to be incorporated under Texas law, however it incorporated itself under Cayman law
o President of Southern Gulf wrote to Bowman (pres of Camcraft) informing him that the incorporation was under a different law
o Bowman signed a written acceptance letter – acquiesces that it is a Cayman Corp and it is okay with him (value appreciated)
o Camcraft defaulted and Southern Gulf sued (seeking specific performance and damages)
Ø Defendant sought to escape liability based on the legal status of the plaintiff (even though they knew about it)
o Saying plaintiff has no legal status
o Trial court said no contract
Ø Whether the defendant should be estopped from asserting the plaintiff’s lack of corporate capacity at the time the Contract was executed after dealing with plaintiff as a corporation
o Where a party has contracted with a corporation, and is sued upon the contract, neither is permitted to deny the existence or the legal validity of such corporation —–CORPORATION BY ESTOPPEL
§ Court had a problem that the defendant’s rights were not substantially affected because this was a Cayman corp. and not a Texas corp. — in fact they got a windfall (by selling at the higher price) – it offended the court
§ The main reason they defaulted was because the ship appreciated in value and they wanted more money
De facto corporation – in fact (substance over form)
Ø not properly incorporated, acted as if a corporation
o trying to enforce contracts and keep people from wiggling out of contract and protect limit liability of shareholders)
o in Florida and Model Bus Act – §2.04 and § 607.0204 – Courts will not recognize the de facto doctrine if people acting on behalf of corporation if they are acting with actual knowledge of lack of incorporation
Ø acted in good faith and thought you were incorporated
De jure corporation – at law (form over substance)
Ø formed in accordance with all applicable laws (filed articles)
corporation by estoppel – if person dealing with corp. thought it was a corp. all along and would earn a windfall if not a corp. then this would be corporation by estoppel
Ø promoting justice and equity
Ø persons who treat an entity as a corporation will be estopped from later claiming the entity was not a corporation
HYPO – business man asks you to org a corp. to buy real estate and he needs a computer. He buys computer in name of corporation. IBM thinks they are dealing with corp. Business fails. IBM sues corp. for purchase price. Business man discovered lawyer never incorporation. Business man acted in good faith and tried to be a corp.
Ø De facto
o thought he was incorporated, acted in good faith – de facto elements
o businessman not personal liability – liable for his investment
HYPO – IBM hypo – company never incorporated and ordered $100,000 in computers. Computers appreciate before date of delivery. IBM discovers no incorp and refuses to deliver.
Ø Corp. by estoppel – IBM cant deny the legal status after they already recognized it (they would be getting a windfall)
o This is like the Southern Gulf Marine v. Camcraft case
HYPO – ABC trucks (owns fleet) One of trucks runs over pedestrian. Ped. wants to sue. ABC is not a de jure corp. What is outcome?
Ø No estoppel — they didn’t choose to deal with corp.
o Usually in tort case, cant get estoppe
e corporation
o Mixing assets among those 10 companies
o Possibility when the defendant has been sloppy with corporate formalities
o You go after corp assets — not personal assets
o Must have fraud ——–
o Doesn’t help if draining out money – no money in corps.
Ø Alter Ego doctrine — agency
o Where corp. form is just a sham for business activities of sole shareholder, courts can disregard the entity as alter ego of shareholder
o Agency relationship in order to hold principle liable —- you must demonstrate principle exercises control over agent
o Here principle needs to be Carlton – agent would be the corporation
§ This doesn’t fit because shareholder control the corp. (the manager does)
§ He would be a director or CEO (no veil to pierce)
Ø How does agency theory differ than piercing the corporate veil?
o Fraud (which you need to pierce veil)
o You don’t need fraud in agency theory (totally irrelevant)
In Florida, disregard of corp. form – will not pierce veil unless there is a wrong or injustice
Ø Commingling of assets
Ø Stripping corp. of cash
Piercing corporate veil – who do you hold liable???
Ø All the shareholders
Parent Corporation – parent is shareholder of subsidiary
Subsidiary –
If you are trying to reach assets of shareholder — this is piercing the corporate veil (goes north and south)
If you are trying to disregarding corporate barrier among different corporation as if they are one corporation — enterprise liability (goes east and west)
There are three recurring situations in which the veil is often pierced:
when corporate formalities are ignored
when the corporation is inadequately capitalized at the outset and
to prevent fraud
ALTER EGO THEORY –
If a corporation is the alter ego, agent, or mere instrumentality of a sole proprietor or another corporation, its separate identity may be disregarded.
Ø If shareholders treat assets of corporation as their own. The operation of the corp. must result in a basic injustice
Ø A subsidiary will not be deemed separate corp. if the formalities are not observed
INADEQUATE CAPITALIZATION
Shareholders will be personally liable if at incorporation they fail to provide adequate capitalization. Can not prove by merely showing corp is insolvent.
Ø No absolute test has been formed
Ø A parent corp’s inadequate capitalization of subsidiary may constitute constructive fraud
FRAUD
The corporate entity will be disregarded any time it is necessary to prevent fraud or to prevent an individual shareholder from using the corporate entity to avoid his existing personal obligations.
Ø Avoiding liability – the mere fact that an individual chooses to adopt the corporate form of business to avoid personal liability is not, of itself, a reason to pierce the corporate veil
Ø Fraud – the corporate veil will be pierced whenever the avoidance of personal liability through the formation of a corporation operates as a fraud on creditors or other outsiders
Sea Land Services v. Pepper Source
Facts: Pepper Source contracted with Sea Land to ship sweet peppers. Pepper Source then did not pay their bill ($87,000). Sealand sued Pepper Source, got default judgment; the corp. was dissolved and no assets to go after. Sealand brought action against Gerald Marchese, who was sole shareholder in PS and other corps (and 50% shareholder in a corp. with Andre). Sued Marchese, PS, and all other corp. Marchese was involved in
§ Wanted to pierce veil of PS and pursue Marchese
§ Then wanted to reverse pierce the other corps to get their assets
Ø Court applies the Van Horn test
o A corporate entity will be disregarded and the veil of limited liability pierced when two requirements are met: (VAN DORN TEST)
§ There must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist
§ Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice
