BUSINESS CORPORATIONS FALL 2013 – BURKHARD
Businesses and Lawyers
Why Does Someone Own a Business?
A. Reason for going into business: make money.
But business owners are interested in more than making money.
Sometimes companies will be organized not to make money (non-profits)—such as pro bono firms, hospitals, BlueCross BlueShield.
Business Example: Milton Friedman: as a corporate executive, the manager is the agent of the individuals who own the corporation and his primary responsibility is to the shareholders.
· Doctrine of Social Responsibility—use a company’s resources and engage in activities designed to increase its profits so long as it stay within the rules of the game, which is to say, engages in open and free competition without deception or fraud.
WHAT IS AN AGENT?
· Agent is the fiduciary relationship that arises when one person manifests assent to another person that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act. (pg E1 §1.01)
Views of Courts and Legislatures
A.P. Smith Mfg. Co. v. Barlow (president)
i. The B.O.D. adopted a resolution that the company should donate $1,500 to Princeton.
ii. When stockholders questioned this, the directors instituted a declaratory judgment action.
iii. Both the president and the chairman of the board say it is a good idea to give the money and it would create goodwill in the community.
iv. Historically, the court says that corporations have given charitable donations.
v. Even though there is a statue which says public policy is in favor of this, the stockholders argue:
1. the company’s certificate of incorporation does not expressly authorize the contribution and there is no implied power to do it, and
2. the statute which authorizes the company to do it can not be constitutionally applied because the company was created long before the statutes were enacted.
vi. There was a common law rule that said donations must benefit the corporation.
vii. Because most wealth is in the hands of corporations, courts have tended to say that the donations do support the company’s objectives.
viii. The court rules that the donation is within the corporations power because of the implied power backed up by the statute (that can be applied to the corporation under the reserve power).
ix. Summary: Court said that laws enacted after incorporation that allowed directors to make charitable gifts without approval from shareholders applied to this corp, and as long as the gifts contributed to the corporate interests, they were appropriate.
x. Why is A.P. Smith in book?
1. A corporation is a separate entity.
2. A body of law-both statutory and common law- has developed to control the actions of that separate entity.
3. Real persons act for that corporation—they are “agents.”
4. A business with more than one owner that is a corporation can distribute and use funds in ways that are opposed by at least some of the owners.
Ultra Vires §33-3-104(C-14): “Not for the benefit of the corporation.” Limits shareholders’ ability to bring lawsuits challenging rights of the company to do things shareholders may think is appropriate. But still permits some challenges.
Except as provided in (b), the validity of corporate action may not be challenged on the ground the corporation lacks or lacked power to act.
A corporation’s power to act may be challenged:
i. In a proceeding by a shareholder against the corporation to enjoin the act;
ii. In a proceeding by the corporation, directly, derivatively, or through a receiver, trustee, or other legal representative, against an incumbent or former director, officer, employee, or agent of the corporation; or
iii. In a proceeding by the Attorney General under 33-14-300.
In a shareholder’s proceeding under (b)(1) to enjoin an unauthorized corporate act, the court may enjoins or set aside the act, if equitable and if all affected persons are parties to the proceeding and may award damages for loss (other than anticipated profit) suffered by the corporation or another party because of enjoining the unauthorized act.
i. i.e. must enjoin everyone
Ultra Vires basically means that the directors should not have done the act.
The Board of Directors is not acting as an agent; it is functionally a principal (this is the common view although the officers waffle on this)
§33-8-101 (C-38): Requirement for and duties of board of directors. (even applies to small fam. Biz)
Provides that Board will manage the company
In theory these are the ones who manage the company – this is true for large corporations, but not for small ones- our statute anticipates this and provides a few other options
Most people say that the Board acts as the PRINCIPAL and not the agent and therefore makes the decisions.
i. Three entities involved in a corporation: Shareholders (owners of the company), directors (make decisions), officers (carry out decisions of board of directors).
ii. When the board acts on behalf of the company, we think of them as acting as the principal because they are the decision-makers.
33-8-103 (C-38) sets the number of BOD.
Certificate of existence and articles of incorporation: A document issued by a state authority granting a corporation its legal existence and the right to function as a corporation- normally filed with Sec. of State
33-1-280 (C-5) Certificate of Existence: Certificate of Existence says that the corporation is in good standing in SC, but 33-1-280 is deceptive—most of the problems a corporation has will not be with the Sec of State, so it will be in good standing even though it is in trouble with other agencies- i.e. Dept of Revenue (taxes are paid to DORànot to Sec. of State)
i. Confirms corp. exists for third parties
ii. Kind of a Good standing certificate from the secretary of state. However, you would need to check on other areas as well (such as department of revenue)
§ 33-2-102 (C-10) Articles of Incorporation: which lists what you have to do to set up a corporation.
i. Must be signature of S.C. lawyer on the form to certify that it is correct (unique to S.C.).
33-3-102 (C-13) provides General Powers of a corporation
Corporation lasts forever unless something happens.
Corporation has the same powers as an individual would have to conduct its business.
NOTE: The powers are those powers necessary or convenient to carry out its business and affairs (thus even if there is a power, a shareholder may argue that it is not necessary or convenient).
(13): A S.C. corporation may make donations for public welfare, or for charitable, scientific, or educational purposes
(15): make payments or donations… that further the business affairs of the corporation.
i. Why do we have 15 if we have 13? 15 is aimed at political contributions.
What if own shares of one co.’s stock and that co. is acquiring a co. that shareholder doesn’t like?
Probably isn’t much that can be done – SELL
Owen Young: some states have incorporated his theory into their statutes- a BOD in making a decision can consider the interests of employees, the interests of the neighborhood, etc.
The major school of thought is that management is worried about stockholders, and everything else is incidental.
Corporation is viewed almost for all purposes as a separate person- an entity, a thing unto itself.
The business lawyer’s client is the corporate entity.
A body of law—both statutory law and case law—has developed to control the actions of that separate entity or person. Statutes play a larger role than the case law.
Real persons act for the corporation—they are agents.
How Does the Owner of a Business Make Money from the Business?
Three Ways of making money
· Receive distributions of all or part of the money the business has earned.
· Sell all or part of ownership interest in the business
· Salary/compensation (most important in small businesses)
How much is the company worth, how much has it made, and how does the owner know?
Legally, there are three groups of persons: the business, its managers, and its owners.
Sometimes one person can fulfill all these roles.
· Corporations shall furnish its shareholders annual financial statements.
o Balance Sheet
o Income Statement
o State of Changes in Shareholder’s Equity
o Should be accompanied by statement saying how it was calculated and should be sent to every shareholder with 120 days of the end of the fiscal year
33-16-220-C99 (Annual Report)
· Every corporation organized in SC and every corporation qualified to do business in SC shall file an annual report. This report has information about the company and is public record and has information for litigation.
· 33-16-101 (C-96) Corporate Records (much more precise in what financial statements must be prepared).
§ (b) “appropriate accounting records”
§ Note: parallel partnership statement is 33-41-520 (A7)
· Parallel LLC statute (B16)
FOR A PARTNERSHIP- 33-41-530-A7 (Right to Info)
· Partners shall render on demand true and full information of all thing affecting the partnership to any partner or legal representative of any deceased partner or any partner under a legal disability.
· 33-41-520-A7- (records)- says have to keep books in accordance with partnership agreement and all partners must have access to them.
FOR AN LLC- 33-44-408-B16 (Member’s Right to Information)
· LLC shall provide access to records if any access to records, operating agreement; no indication of exactly what LLC should maintain. (Practically most business keep the same three financial statements.
Income Statement: computes the profit of a business for the period in question, usually one year.
i. When you buy an item that will be used over one year, you will depreciate that item (such as a machine) and only the depreciated value for that year will be included in the income statement.
ii. Most business owners would rather charge more expenses in an earlier year rather than in a latter year (accelerated) because they would pay less tax.
iii. An income statement will also include both federal and state income taxes.
iv. Formula = Income – Expenses – Depreciated value of assets – Taxes= Net Income
Cash Flow Statement: a measure of how much more cash a business has at the end of the year than it had at the beginning of that year.
i. When you have depreciation, the income position is going to be different from what the cash flow position is going to be.
ii. Cash flow = profit after tax + depreciation – investment.
1. You add back in depreciation because it is a non-cash expense.
2. You subtract investment because that was cash spent.
iii. Expense: Something that the company buys and will use up within the year
1. Salaries, G&A, and COGS are expenses
iv. Investment: Business buys something that can be used for more than one year
1. Calculate this as a depreciation on an income statement
Balance Sheet: a statement, usually prepared at the end of the company’s fiscal year, that shows what assets the company owns and what liability and equity the company has.
i. Assets are on the left side and liabilities and equity is on the right.
1. Assets on one side (include things like cash, land, buildings, accounts receivable, and machinery and equipment)
2. Liabilities on the other (include things like accounts payable, wages payable, and debts)
3. Assets = Liabilities + Stockholder Equity or
4. Owners’ equity = assets – liabilities
ii. Equity is on the right because that is the amount of money owed to the shareholders, and thus, it is a type of debt or liability.
iii. If you have total assets of 189,000 and 109,000 in liabilities, and 80,000 in equity, what would you want to sell the business for?
1. 189,000 (its assets)? No. That's only assets, doesn't include debts or other things.
2. 80,000 (its equity)? Maybe.
a. At least if you liquidate day after sale then you could get $80K
Most closely held businesses are normally sold considering its earnings, and the balance sheet does not show anything about its earnings.
structure look at:
Who will the investors and owners be? If small group of investors- then an LLC or partnership would work.
What are the capital requirements and cash flow characteristics of the business likely to be?
If you require venture capital, you will probably need to be a corporation because venture capitalists won’t invest in LLC because of the personal tax liability.
But this isn’t really the case- people still invest, and it’s easier to change from an LLC to a corporation – but not visa versa.
Who will own the business?
Who will manage it?
Who will reap any profit?
Who will bear the risk of loss?
Who will pay taxes on profits?
D. Note: If you operate a business under a particular name, the name does not belong to you unless you acquire a common law right to a name.
If the name qualifies as a trade name or service mark, then there may be some statutory protections.
Agency and Sole Proprietorships
A. The good things about sole proprietorships:
You don’t need a lawyer or any forms to start one (just start doing business).
Agency: Agency is the fiduciary relationship that arises when one person (the principal) manifests assent to another person (the agent) that the agent shall act on the principal’s behalf and subject to the principal’s control and the agent manifests assent or otherwise consents to the act. Restatement (3rd)
The law of agency helps businesses operate.
There are two Restatements for Agency.
i. Restatement (2nd) is what South Carolina has always used.
1. Agency is a result of conduct, not words in contract.
ii. We will focus on Restatement (3rd). (There is a conversion table on TWEN).
Employees and Agency – Creates Contract Liability
Definition of Agency: R-3 1.01 (E1)
i. Agency is a fiduciary relationship. Created when:
1. The principal manifests assent to act on his behalf to the agent.
a. Consent is manifested when (1.03):
i. Written or spoken words
ii. Other conduct
2. The agent assents to act on the principals behalf subject to his control.
ii. NOTE: Agency is the result of conduct, not words
Authority: The extent of the agent’s power to act and bind the principal.
i. Looking to at what point will the agent bind the principal.
i. Authority to do an act can be created by:
1. Written or spoken words (express authority), or
2. Other conduct (implied authority).
ii. Which reasonably causes the agent to believe that the principal wants the agent to act on the principal’s account.
iii. RS3-3.01 Created by P’s manifestation to an agent that is reasonably understood and expresses P’s assent that he wants A’s to take action on his behalf
Implied Authority: Recognizes that an agent has the authority to do what is reasonably necessary to get the assigned job done, even if P did not spell it out in detail.
Apparent Authority – RSA-3d § 2.03 (E3)
i. Apparent authority is the power held by an agent or other actor to affect a principal's legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations.
ii. Created by P to TP
iii. Giving an agent a job that typically carries an authority can create apparent authority.
Disclosure of Principal – When the agent and principal is liable for a contract.
i. RSA § 6.01 – When an agent acting with actual or apparent authority makes a contract on behalf of a disclosed principal,
1. (1) the principal and the third party are parties to the contract; and
2. (2) the agent is not a party to the contract unless the agent and third party agree otherwise.
ii. RSA § 6.02 – When an agent acting with actual or apparent authority makes a contract on behalf of an unidentified principal,
1. (1) the principal and the third party are parties to the contract; and
2. (2) the agent is a party to the contract unless the agent and the third party agree otherwise.
iii. RSA § 6.03 – When an agent acting with actual authority makes a contract on behalf of an undisclosed principal,
1. (1) unless excluded by the contract, the principal is a party to the contract;
2. (2) the agent and the third party are parties to the contract; and
3. (3) the principal, if a party to the contract, and the third party have the same rights, liabilities, and defenses against each other as if the principal made the contract personally, subject to §§ 6.05-6.09.