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Chapter15DirectorsOfficers2.ppt

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Nature and Classification
of Corporations

Corporation: formed in compliance with statutory requirements, is a legal entity separate and distinct from its shareholder-owners

Personnel: The shareholder-owners elect directors, who set policy and hire officers to run the day-to-day business of the corporation.

Constitutional
Rights of Corporations

Corporation is a legal “person” under state and federal law. Corporation has right to:

Due process,

Equal protection,

Speech,

Access to Courts,

Freedom from unreasonable search and seizure.

A corporation does not have 5th amendment right to remain silent.

Corporations

Limited Liability of Shareholders: Shareholders normally are not personally liable for the debts of the corporation.

Corporate Taxation: The corporation pays income tax on net profits; shareholders pay income tax on disbursed dividends.

Retained Earnings.

Torts and Criminal Acts

The corporation is liable for the torts committed by its agents or officers within the course and scope of their employment.

In certain situations, corporate officers may be held personally liable for corporate crimes.

In some circumstances, a corporation can be held liable (and be fined) for the criminal acts of its agents and employees.

Classification of Corporations

A corporation is referred to as a domestic corporation within its home state (the state in which it incorporates).

A corporation is referred to as a foreign corporation by any state that is not its home state.

A corporation is referred to as an alien corporation if it originates in another country but does business in the United States.

Incorporation Procedures

The corporation is a legal entity distinct from its owners.

Formal statutory requirements, which vary somewhat from state to state, must be followed in forming a corporation.

Selecting the State of Incorporation

Securing the Corporate Name

States review corporate names to avoid duplication and deception. All state require that a name include Corporation, Incorporated, Limited, Company, or and abbreviation of one of these terms. A name should also be able to serve as a domain name.

Incorporation Procedures

Preparing the Articles of Incorporation

The articles include basic information about the corporation and serve as a primary source of authority for its future organization and business functions. Typically, the articles include the corporation’s name, duration, nature, purpose, capital structure, internal organization, and registered office and agent, as well as the names and addresses of the incorporators

First Organizational Meeting

After the corporation is created it can do business.

Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities.

Defects in Formation and
Corporate Status

If the procedures for incorporation are not followed precisely, others may be able to challenge the existence of the corporation.

Problematic for shareholders who may be personally liable.

In addition, the corporation may not be able to enforce contracts.

Improper Incorporation

De Jure: substantial statutory requirements are met; cannot be attacked by state or 3rd parties.

De Facto: statutory requirements not met, but incorporators made good faith effort to comply with corporate law; corporate status can only be attacked by state.

By Estoppel: if it acts like a corporation, cannot avoid liability by claiming that no corporation exists.

Corporate Powers

A corporation may act and enter into contracts as any natural person, except as limited by:

U.S. Constitution.

State constitutions.

State statutes.

Its own articles of incorporation.

Its own corporate bylaws.

Resolutions by its own board.

Ultra Vires Doctrine

When a corporation actions are beyond the express or implied powers of the corporation as stated in the state statute or the corporation’s own articles of incorporation. These actions are considered to be “ultra vires” (beyond the powers).

Corporation’s articles of incorporation are usually very broad to prevent lawsuits against the corporation.

Piercing the Corporate Veil

“Piercing the Corporate Veil” occurs when a court, in the interest of justice or fairness,” holds shareholders personally liable for corporate acts.

Court concludes that shareholders used corporation as a “shield” from illegal activity.

Piercing the Corporate Veil Cont…

Factors a court considers:

3rd party tricked into dealing with a corporation rather than the individual.

Corporation is set up never to make a profit or remain insolvent or is under capitalized.

Statutory formalities are not followed.

Corporation is set up to evade an existing legal obligation.

Personal and corporate interests are commingled (mixed together).

Directors and Officers

Every corporation is governed by a board of directors that are elected by the shareholders.

Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation.

A director can also be a shareholder, especially in closely-held corporations.

Election and Compensation
of Directors

Subject to statutory limitations, the number of directors is set forth in the articles of incorporation:

Directors appointed at the first organizational meeting.

In closely held companies, directors are generally the incorporators and/or the shareholders.

Term of office is generally for one year.

Director can be removed for cause (for failing to perform a required duty).

Compensation of Directors.

Inside vs. Outside director.

Board of Directors’ Meetings

Directors hold meetings pursuant to bylaws with recorded minutes.

Special meetings may be called with sufficient notice.

Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority).

Each director generally has one vote.

Rights of Directors

Directors have the right to:

Participate in corporate decisions and inspect corporate books and records.

Compensation

Indemnification - If a director is sued the corporation should guarantee indemnification or purchase liability insurance to protect the board from personal liability.

Committees of the
Board of Directors

Executive Committee.

Audit Committee.

Nominating Committee.

Compensation Committee.

Litigation Committee.

Officers and executives are hired by the board of directors.

Act as agents for the corporation.

In most States a person can be both an officer and a director.

Officers are employees of the corporation and have fiduciary and loyalty duties.

Corporate Officers and Executives

Officers have fiduciary duties to the company. The Board, and individual Directors also have a fiduciary duty to the company.

Officers employment relationships are generally governed by contract law and employment law.

Officers may be terminated for cause.

Directors have general responsibility for all management decisions:

All major corporate policies.

Appointment and removal of all corporate officers and their compensation.

Financial decisions, including dividends and retained earnings.

Duties and Liabilities of
Directors and Officers

Fiduciary Duties of
Directors and Officers

Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders:

Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable.

Duty of Care (cont’d):

Make informed and reasonable decisions;

Rely on competent consultants and experts; and

Exercise reasonable supervision.

A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.

Fiduciary Duties of
Directors and Officers

Business Judgment Rule

Immunizes a director or officer from liability from consequences of a business decision that turned sour.

Court will not require directors or officers to manage “in hindsight.”

As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply.

Duty of Loyalty: subordination of personal interests to the welfare of the corporation.

No competition with Corporation.

No usurping of “corporate opportunity.”

No conflict of interests.

No insider trading.

No transaction that is detrimental to minority shareholders.

Case 15.3.: Guth v. Loft, Inc., 1939 What were the two parts of the duty test the court used to determine whether the corporate executives had violated their duty of loyalty?

Fiduciary Duties of
Directors and Officers

No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally.

However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors.

Fiduciary Duties of
Directors and Officers