Business Organizations, Fall 2011, Prof. Chuck Willey
Generally:
– Corporate law works best for large groups (default rule– centralized management)
– Continuous duration
o Unlike a partnership, there are no events of disassociation what can cause a dissolution
– Limited liability: the owners (shareholders) are not liable for the debts of the corporation (unlike partnership)
– Free transferability of interest
o Unlike a partnership, a shareholder can freely transfer his own ownership interest (although shareholders can enter agreements to reasonably restrict transferability)
– Like a partnership, a corporation can only act through its agents, including directors, officers and employees; these agency relationships create fiduciary duties
– The owners of the corporation are the shareholders
– Shareholder power:
o Unlike partners, do not have a right to manage
o Vote for Board of Directors (who do manage the corporation)
o Board of Directors then appoints President, CEO, etc.
– By Articles of Incorporation, can change voting rights, management and distributions
– KNOW WHAT CONSTITUTES FRAUD (WALKOWSZKY CASE)
Creation:
– Can’t inadvertently become a corporation (differs from partnership)
– Who may incorporate → anyone, even if they have no interest in the corporation
– How to incorporate → file Articles of Incorporation with Secretary of State (they don’t automatically form)
o MBCA § 2.02 sets forth what must be contained in the Articles of Incorporation
§ Name:
· 4.01– must contain “corporation” or similar language; must be distinguishable from names of other corporations; and
· In MT, must also be distinguishable from assumed business names, LLC’s, trademarks
§ Number and classes of shares the corporation is authorized to issue
§ Street address of the corporation’s initial registered office and the name of its initial registered agent
· Registered office must be in the state of incorporation; registered agent must be in the state of incorporation (see MBCA § 5.01)
§ The name and address of each incorporator
o Generally, the incorporator signs the articles (MBCA § 1.20(f))
§ The signature does not have to be notarized on any document filed with the Secretary of State (MBCA § 1.20(g))
· Some states, not MT, do have a notarization requirement
§ After corporation has been formed and directors elected, future filings are signed by the chairman of the board, a president, or another corporate officer.
o The Articles of Incorporation are effective when the articles are filed, unless a later date is specified in the Articles. (MBCA § 1.23). You cannot specify an earlier dates as an effective date, only a later date.
o Optional matters in the Articles of Incorporation:
§ MBCA § 2.02(b) allows any of the following provisions which are not inconsistent with law:
· Initial directors
· Purposes
· Management
· Defining, limiting and regulation the powers of the corporation, its directors or shareholders:
o What if you represent a company which holds a liquor license, and the regulators prohibit a holder of a liquor license to own another liquor license; would you put a limitation on the number of liquor licenses it can own in the Articles?
· Different classes of shares
· Par value for shares – assign a value to shares and then corporation can’t accept less than par value
· Imposition of personal liability on shareholders
· Limitation on director liability– can’t totally eliminate
· Indemnification provisions for directors– can’t totally indemnify
§ Default Rules may want to override in the articles
· Term versus perpetual
· Grant of preemptive rights
· In MT, opt out of cumulative voting (under MBCA, no cumulative voting uless you opt in)
· Staggered terms for directors (if 9 or more directors)
· Restrictions on transfer of shares
· Non-voting shares
· Increased voting or quorum requirements (require supermajority votes in certain situations, such as amending the articles)
· Reserve certain powers (such as power to issue new shares) to shareholders
o Hold organizational meeting soon thereafter
§ Elect directors if not named in Articles
§ The directors immediately convene their own organizational meeting (if directors are named in Articles, the incorporators don’t have to meet to elect them). (MBCA § 2.05)
§ At the organizational meeting, the directors adopt by-laws; order corporate minute book, seal and shares; elect officers; authorize issuance of shares and determine the appropriate consideration a shareholder must pay for his shares; select bank, accountant, attorney; determine what equipment and other start-up assets to purchase; decide where to operate; and any other organizational matters.
o By-Laws
§ By-laws govern the internal operation of the corporation
§ If there is a conflict between by-laws and the Articles, the Articles control (MBCA § 2.06)
§ The by-laws may be amended by either directors or shareholders (MBCA § 10.20)
§ The Articles may reserve the power to amend by-laws to the shareholders
§ By-laws typically address:
· How and when meetings of shareholders and directors are conducted;
· Voting (establishing quorum, authorizing proxies, majority vs. supermajority, voting agreements between shareholders)
· Duties and qualifications of officers;
· Number, term and qualifications of directors;
· How to fill director vacancies;
· Committees of directors;
· Procedures for transferring share certificates and replacing lost share certificates;
· Restrictions on transferability of shares;
· Maintaining corporate records;
· Arbitration procedures;
· Amendments to Articles or by-laws; and
· Any other organizational/ management matters.
Partnerships
Corporations
Liability
No limited liability – partners and partnerships liable
Limited liability – just the corp itself and not the shareholder
Dissolvability
Term –
at-will – easy to dissolve
Continuous duration – not easy to dissolve
Management
Partners manage w/ equal votes
Centralized management – Bd of Directors elected
Owners
Partners
shareholders
Transferability
Default – requires unanimous consent
Shares easily transferable
Promoters and the Corporate Entity
– A promoter is a person who sets into motion the incorporation and organization of a corporation;
– Brings together persons interested in investing; may take steps such as lining up employees, finding office spaces
– A promoter is in a fiduciary relationship with the corporation and the shareholders.
Premature Commencement
– If you act on behalf of a corporation that doesn’t exist, then you are personally liable
o Filing of Articles of Incorporation will erect limited liability shield
– MBCA § 2.04 provides a provision to determine when persons are responsible for a pre-incorporation debt: “all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this act, are jointly and severally liable.”
– Equity courts have developed several theories to protect those individuals:
o De Jure corporation– arises when the corporation has substantially complied with the statutory requirements, but there has been some discretionary or relatively small non-compliance. E.g. the name of the corporation’s registered agent is wrong.
o De Facto corporations
§ Corporation arises when there was
· A good faith (but defective) attempt to incorporate; and
· The actual use of the corporate form.
o E.g. John mails Articles of Incorporation to the Secretary of State on Jan. 10, but uses the wrong address. Reasonably believing that he has allowed enough time for the Articles to arrive at the Secretary of State’s office, on Jan. 17, John signs a contract on behalf of the corporation. On Jan. 20, John receives the envelope back because of the wrong address. John may raise a de facto defense.
· MT does NOT recognize de facto corporations.
the pro rata distribution of additional shares of the corporation among existing shareholders. For example, each shareholder who owns one share of Intel receives one new share. A stock dividend is NOT treated as a distribution.
· (see legal restrictions on dividends below)
§ Stock Redemption:
· John owns 25% of the family corporation which operates a restaurant. She transfers all of her shares to the company, in exchange for $25,000, which the parties agree is fair value for his shares. The stock redemption affects the percentage of ownership of the corporation of the other stockholders
§ Capital Distribution:
· The X Ranch Company owns a ranch and a golf course. There are three shareholders. The corporation distributes the golf course to the shareholders, retaining the ranch. This is a distribution.
o MBCA § 6.40(f) places the authority to authorize distributions with the Board, subject to any restrictions in the Articles, and subject to any restrictions imposed under MBCA § 6.40(c).
o Legal Restrictions on Dividends:
§ MBCA § 6.40: corporation can only pay dividends to shareholders when:
· Corporation has enough funds to pay debts as they become due– cash flow analysis
· You don’t owe more than you own– can’t have negative debt situation (solvency)
§ What can the directors rely upon in determining if these tests are met? See MBCA § 6.40(d) – on financial statements or on a fair valuation or on any other reasonable method.
§ What if a distribution is made in violation of MBCA § 6.40(c)? – Under MBCA § 8.33 a director could be personally liable if he did not meet the duty of care set forth in MBCA § 8.30.
Shareholders vs. Directors
– Shareholders
o The shareholders are the owners of a corporation, but they do not have the right to manage the affairs of a corporation. (in contrast, general partners are both owners and also have the right to participate in management)
o What items does a shareholder have the right to vote on?
§ Elect directors (MBCA § 8.03(d))
§ Remove directors, with or without cause (MBCA § 8.08(a))
§ Amend the Articles of Incorporation (MBCA § 10.03) (but see MBCA § 10.02, some areas the directors may amend)
§ If there are classes of shares, shareholders of that class have right to vote on changes affecting that class (even if the share are otherwise non-voting shares) (MBCA § 10.04)
· Under MBCA § 10.04, the holders of the outstanding shares of a class are entitled to vote as a separate voting group when the shares in their class will be changed (increased/decreased; rights changed; e.g. if a change is proposed to a class of preferred shares, it requires the approval of a majority of those preferred shareholders before the proposal may become effective)
§ Amend by-laws; directors also have a right to amend (unless exclusively reserved to the shareholders in the Articles) (MBCA § 10.20)
§ Merger; share exchange (MBCA § 11.01)
§ Sale of assets other than in regular course of business (MBCA § 12.02)
§ Dissolution (MBCA § 14.02)
o Those items on which a shareholder can vote (merger, sale of assets) require a majority vote (see MBCA §§ 11.03(3); 12.02(3)), but the Articles may impose a supermajority.
o Under MT law, a 2/3 vote is required for a merger of for sale (MCA § 35-1-815(5) (unless the Articles provide for a majority)
