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Business Associations
University of North Carolina School of Law
Hazen, Thomas Lee

Hazen – Business Associations – Fall 2016

Corporate Formation

Formalities

State corporate statutes set out requirements to comply with before corporation is validly formed (most states follow MBCA)

UNTIL ENTITY COMMENCES, IT’S A PARTNERSHIP

File Articles of Incorporation (AOI) with Secretary of State (MBCA 2.03)

Usually 1-page including

Business name
Address
Number of stock shares authorized for issue

ID type and rights/privileges/preferences enjoyed by each class if multiple classes authorized

Name and address of incorporators

Require shareholder vote to amend (MBCA 2.02)
Filed when Secretary of State accepts as filed (as in NC)
State size of BoD

Bylaws can state as well in most states now

RMBCA Does NOT require corporate purpose, powers, names of initial directors

Corporate name must include “corporation,” “incorporated,” “company,”

Or “limited”

Must be unique and not deceptive
Share subscriptions must be secured to have operating capital before incorporating
Office and agent must be arranged for in state of incorporation
Bylaws: MBCA 2.06 states these = the rules governing corporate operations

Board may amend bylaws
May be drafted by promotors OR board
Anything that can be in bylaws can ALSO be in Articles

If inconsistency between Articles and Bylaws, then ARTICLES rule

Organizational Meetings

MBCA 2.05 – issue stock, appoint officer, ratify Ks

Secure Payment of share subscriptions (MBCA 6.20)
Federal Securities Laws’

If public SH, then necessary to comply with Fed and State securities law for EVERY state you will do business in

Issue Shares (MBCA 6.21)
Qualify to do business in other states as foreign corporation

Defective Incorporation

Incorrectly incorporated business/those without Articles approved by state means that business is acting as PARTNERSHIP NOT CORP (join & several liability)

Under age of 21 as incorporator, failure to file Articles, confusingly similar name, failure to issue stock, etc.

Doctrines Limiting Harshness

De Facto Corporation Doctrine

SH/owners believed in good faith that they had organized, but some defect of incorporation process prevented business from being “de jure” corporation

“De Jure” – business that has fulfilled formation requirements according to regulations for earning a state charter

Liability imposed on those who act on behalf of a corp. while “knowing” it doesn’t exist yet
Elements

Statute under which business could be incorporated with “colorable compliance” that failed for some reason
Good faith attempt to organize as corporation
Use of corporate franchise (acted as a corporation would)

Corporation by Estoppel

Prevents 3rd party dealing with corp. while believing it to be a corp. from later denying it was a corp. in trying to hold officers/SH personally liable for Ks
Requires that corporation was dealt with as a corporation by P
Cranson v. IBM Corp – IBM treated as corp. and there was no personal guarantee, so IBM is estopped from denying corporate existence and holding Cranson personally liable

MBCA on Defective Incorporation

2.03 – corporate existence commences at filing

Courts split on if de facto corp. survives 2.03 due to this; better chance that corp. by estoppel has survived

2.04 – liability is imposed ONLY on those who act on behalf of non-existent corp. KNOWING that corp didn’t exist yet

Most states have NOT adopted 2.04 (NC included)

Means De Facto & Corp. by Estoppel still exist

Capital Formation

Basic Financial Forms

Stock (equity/ownership in corporation)

Certificate shows ownership; no such thing as guaranteed dividend!

Bonds (corporation owes owner a debt)

Debt is borrowed from public, certificate containing promise to repay the principal + interest at future date
Debtors and bondholders HAVE PRIORITY over SH at liquidation

Bondholders have contractual right to their investment

Remember: directors can issue bonds (borrow) WITHOUT SH APPROVAL

Directors issue shares, but to be issued it must be authorized by articles

Types of Stock

Common: represents proportional ownership in corporation

Holds right to vote to elect directors and other issues submitted to SH
Holds right to proportional share of dividends declared by BoD
Charter can vary rights, thus creating classes of common stock and differing voting and dividend rights

Preferred: gives owner preference over common SH in receipt of dividends upon liquidation AND when dividends are issued

Dividend rights may be cumulative or non-cumulative

Cumulative: dividend accrue over missed years

Because it’s redeemable, it’s more like debt (if redeemable/callback-able)

Non-Cumulative: no accrual over missed hear

May be convertible stocks or bonds

Convertible Bond: holder may elect to convert holding into common stock under formula expressed on bond
Convertible Preferred Stock: allows conversion to common stock

Takes one from non-participatory preferred/bond holder to participating common stock holder

Preferred & Redeemable/Recallable Bonds

Corp. has “call option” to buy stocks/bonds back according to price/formula specified on it (if stock, then in Articles)

Par Value: lowest value which stock can be sold; cannot go lower, but can issue/sell at higher (still retained in DE law)

Balance Sheets – must balance sum of assets on left with sum of liabilities, equity investments, and retained earnings on right
Risk of Loss

Priority Hierarchy

Secured debt (asset backed)
Subordinated secured debt (debt agreed to subordinate claim behind secured debt in exchange for higher interest rate)
Unsecured debt (Promise to pay; IOU)
Subordinated unsecured debt

on-functioning of officers and directors other than as dominant shareholders
Absence of corporate record
Use of corporation as façade for the conduct of shareholder business

Normally requires at least two of these:

Gross undercapitalization
Fraud or wrongdoing
Failure to follow corporate formalities

Equitable Subordination

Court decision to subordinate controlling SH claims on debt owed to them by their own firm to “outside” creditors during a bankruptcy
Debts are subordinated if there is an equitable reason
Deep Rock Doctrine: where a corporation becomes insolvent, debts owing to SH may be subordinated to the claims of other creditors

1.Equitable remedy available where bad faith by the SH is established because of undercapitalization or mismanagement

Ultra Vires

If corporation enters into K beyond scope of power, then K is illegal
Occurs when corporation has limited purpose clause in its Articles
MBCA 3.01 – incorporation under this eliminates this problem as ALL companies have ALL purposes under MBCA
Fixes

Implied Powers Doctrine – rather than let corp. avoid obligation, court will imply the power into the purpose clause of the company
All Purpose Clause – corps are generally permitted to enact an all-purpose clause under MBCA 3.01

Unless articles state otherwise, corp. has purpose of engaging in ANY lawful business

Not a defense when:

MBCA 3.04 – (a) action by SH challenging corporate act (b) action by corp. against officers, directors, or employees (c) action by state (attorney general)
Ultra Vires CANNOT be used by 3rd parties as defense (“we cannot fulfill this K because it’s UV”)

Corporate Responsibility

Is private business acting UV when doing something out of public interest rather than for profit of SH?

AP Smith Mfg. v. Barlow: If it can be found that contribution furthers business in some way, then NOT UV

MBCA 3.02(13) – Unless Articles provide otherwise, corp. may “make donations for public welfare or charitable, scientific, or educational purposes”

Adams v. Smith: giving money to widows (private parties) of directors = corporate waste and thus UV

Could do if (a) consideration OR (b) in executive’s K OR (c) had in corporate charter

Constituency Statutes

28 states have statutes allowing board to consider interest other than SH wealth in decisions (but don’t HAVE TO)