OUTLINE: CORPORATIONS

Raechelle C. Yballe

University of Akron School of Law

Spring 2002

Prof. Moritz

I. Introduction

A. Promoters’ Contracts

Promoter = person who organizes a business

i. Promoters undertake K’al obligations on behalf of the corporation to be formed (nonexistent!)

Corporation is not bound by terms of K – may accept or reject
Examples of undertakings

i. Arranging for office space

ii. Hiring employees

iii. Purchasing capital equipment

Ratification

i. Accomplished formally when BoD adopts resolution ratifying acts of promoter

ii. Effect of ratification is retroactive

Adoption

i. Corp binds itself to promoters’ contracts by adopting them

ii. Does not have a retroactive effect like ratification

iii. BoD passes a resolution stating that it adopts the K

McArthur v. Time Printing

i. FACTS: P contracted with D for his services as advertising solicitor for corporation that did not yet exist; P’s services to begin Oct 1.; corporation not organized until Oct. 16.

ii. Corporation is not bound by engagements made on its behalf by its promoters before its organization BUT may make such engagements its own contracts

iii. Formal action by BoD only needed in cases where a similar original K would required approval by BoD

iv. Express adoption or acceptance is not required; it may be inferred from acts or acquiescence on the part of the corp or its authorized agents

v. K must be one which the corporation itself could make and on which usual agents of corp have express or implied authority to make

B. Rights and Liabilities of Promoters

GENERALLY, promoter is personally liable under a promoters’ K

i. § 2.04 – all persons purporting to act as or on behalf of a corp, knowing there was no incorporation under this Act, are jointly and severally liable for all liabilities created while so acting.

Whether promoter is bound by promoters’ K depends on

i. Parties’ intent

1. LIABILITY if promoter signs in the name of to-be-formed corp. but does not tell the other party that the corp has not yet been formed

ii. How K was drafted

1. should include language that clearly states the other party will look only to the to-be-formed corp for performance (must be supported by additional consideration!)

2. secure a written option that grants to promoter, for benefit of to-be-formed corp, an option to enter into specified K

Avoiding Liability after Adoption

i. In K, include language that contemplates an automatic novation upon adoption of K by to-be-formed corp

ii. Novation must be effected after to-be-formed corp has adopted K

II. Incorporation

A. Why incorporate?

Limited liability of shareholders – personal assets of SHs will not be used to satisfy corporate liabilities
Perpetual duration
Centralized management structure
Flexible capital structure
Separate entity status
Usual form for most businesses

Disadvantages
1. Filing fees
2. Double taxation (but flow-through S corps allowed)
§6.02 – Incorporation Procedure
1. define scope and nature of business
2. outline capitalization and distribution of securities
3. select and clear corporate name
4. may have to publish intent to incorporate
5. file articles of incorporation with secretary of state

i. § 2.02 requires at least the inclusion of

1. corporate name

2. number of authorized shares

3. name/address of office and agent

4. name and address of incorporators

ii. can modify purpose of corp, perpetual duration, and limited liability

may have to publish articles or notice of incorporation

Purposes Clause
1. Designates the type(s) of businesses which a company may conduct
2. § 3.01 – every corp under MBCA has the purpose of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation
Powers Clause
1. § 3.02 – corp has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs
2. to sue and be sued
3. to acquire and convey real and personal ppty
4. to enter into Ks
5. to lend and borrow $$$
6. ULTRA VIRES

i. COMMON LAW: actions by the corp that were outside the scope of stated corporate power were void (corp lacked power to enter into transaction)

ii. Today, corps not confined to established purposes clause of charter

iii. § 3.04 of MBCA limites ultra vires challenges to SHs, corporation, Attorney General

Pre-incorporation Agreement
1. Spell out terms and arrangements that parties have agreed to
2. Useful when

i. Organization of corp will require a considerable period of time

ii. Extensive financial commitments in advance of incorporation

iii. Participants want to bind one or more to commitments for future financing

iv. One or more participants induced to engage in enterprise using consideration other than shares in the to-be-formed corporation

v. If participants want to restrict transferability of stock

§ 7.32 authorizes pre-incorporation agreements

III. Capitalization

Cash/assets put into the corporation on a long-term basis
Preference Upon Dissolution/Liquidation
1. Secured Credit
2. Unsecured Credit
3. Preferred Stock
4. Common Stock
Equity
1. Generally

i. Cash/assets contributed by shareholders in exchange for stock

ii. Equity owners have residual interest in assets of corp.

iii. Claims paid on liquidation only after superior claims are satisfied

Types of Equity Securities

i. Common Stock

1. if corp only has one type of stock, this is it!

2. owners of corporation

3. holders generally share all rights that SH have in corp

a. rights usually proportional to ownership interest

b. Rights include

i. Voting

ii. Share in profits, if distributed

iii. Share in assets, if corp liquidated

4. may have more than one class of common stock, with different rights

ii. Preferred Stock

1. has priority over common stock if corp liquidated

2. preferred right to receive profits in the form of a dividend

a. usually limited to stated amount

3. cumulative dividend right

a. if no dividends paid to preferred SH, then no dividends paid to common SH until all dividends paid to preferred SH

b. EXAMPLE: max. dividends for preferred stock = $6/yr/share; common share price = $100/share… Pay out might look like this

Year	Preferred	Common
1	$6	$5
2	$3	NO PAY
3	$4	NO PAY
4	$11 (6+3+2)	$5

4. no right to vote in most matters UNLESS dividend not paid for stated period (usually 12 mos.)

5. callable or redeemable at the option of the corp (BoD) – generally purchase price PLUS one year dividend

6. sometimes convertible (e.g. to common stock)

iii. Model Act - § 6.01

1. § 6.01(a) and (c) – permit corp to classes of shares that differ based on preferences, limitations and relative rights

2. § 6.01(b) requires articles of incorporation to authorize (COMMON STOCK)

a. one of more classes of shares that together have unlimited voting rights

b. one or more classes of shares that together are entitled to receive net assets of corp upon dissolution

3. § 6.01(c) – authorizes issuance of shares that (PREFERRED STOCK)

a. Have special, conditional, or limited voting rights

b. May be redeemed at the option of

i. corp

ii. SHs or a 3dp

iii. Upon occurrence of predetermined event

c. May be converted

d. Entitle holders to distributions calculated in any manner, including dividends

e. Have preference wrt distribution upon dissolution

Issuing Equity Securities

i. Par Value

1. dollar value of share specified in the charter, arbitrarily assigned, from which legal consequences flow

a. usually $1 or a fraction of the selling price

b. for preferred stock, corps set par value at or near selling price (often $100/share)

2. Legal Consequences

a. Usually, corp may not issue stock for less than par value

b. When par value shares are issued, dollar figure equal to par value can be shown as stated capital

c. Fees and taxes payable to state of incorporation are based on par value (NOT IN OH)

i. EXAMPLE: 100 shares authorized, par value = $2/share; state would tax based on $200

ii. In DE, if stock has no par value, treat as if it had relatively high par value (e.g. $100/share)

d. Articles of Incorporation may place limits on how stated capital is used and how adjustments are made (Toms v. CMC)

3. MBCA and Par Value

a. § 6.21 – Capital structure is not based on par value and stated capital

b. § 2.02 – Permits articles of incorporation to include par value for authorized shares or classes of shares

c. unclear as to effect on when corp can distribute to SHs

ii. Mechanics of Equity Capitalization

1. Delaware Code

a. Terminology

i. Capital for par stock

ii. Stated capital for non-par stock

iii. Capital surplus = amount of consideration received for shares in XS of the amount of capital/stated capital

iv. Earned surplus = company earnings that have not been distributed to the SHs

b. Shares may be divided into classes

c. § 102(a)(4) – corp may only issue number of shares stated in its charter and must state the par value of it shares OR state that shares are without par value

i. Par value shares

1. consideration may not be set at less than par value

2. can issues shares for greater than par value

3. stated capital must be at least equal to aggregate par value

ii. Non-par value shares

1. stock may be issued for such consideration as is determined by the BoD

2. all consideration received constitutes stated capital UNLESS BoD determines that only part of the consideration is to be stated capital

3. any amount (but not all the consideration) can be designated as capital surplus

d. Types of consideration allowed

i. money

ii. property

iii. labor or services actually performed for the corp

e. if stocks issued for more than par value and if amount equal to par value has been paid à corp may accept binding obligation to pay remaining amount

f. Cash Dividends and Distributions

i. May be paid from

1. current profits

2. earned surplus – payout to SH of corporation’s earnings (a return ON the SH’s investment)

3. capital surplus – distributions generally represent a return OF the SH’s capital not payment of corporate earnings

ii. May NOT be paid from capital account

g. Transfers allowed

i. capital surplus to stated capital à restricts ability to make distributions

ii. stated capital to capital surplus as long as amount left in stated capital is at least equal to the total par value of corp’s issued stock plus some amount representing no par shares, if any

2. MBCA

Debt
1. Types of Debt

i. Bond

1. generally a long-term debt instrument (5-10 yrs.)

2. also a long-term debt instrument secured by mortgage or deed of trust on corporate ppty

ii. Debenture = an unsecured long-term debt instrument

iii. Indenture = K between corp and a bank that acts for the benefit of a bond/debenture holder

Advantages of Debt

i. Interest payment are tax deductible

ii. Issuing notes less expensive that stock

Leverage

Authorized, Paid, Nonassessable Stock
1. Duly authorized = when shares were issued, corporation had sufficient shares authorized in charter to cover the issuance
2. Validly issued = issuance of shares was in accordance with corporation law

i. Did board approve issuance of stock?

ii. Was consideration in the amount and of the type allowed by statute?

iii. Was consideration at least equal to par value of stock?

Assessable stock/fully paid

i. In certain circumstances, corporation has the right to demand future payments from the holders of that stock

ii. If consideration was not paid = owner may be assessed for further payments

iii. SH is liable to corporate creditors to the extent that stock has not been paid for

Thin Incorporation and Subordination
1. Thin incorporation = extent to which SH loans can be used to finance a corporation
2. Obre – where parties could have determined financial status of corporation, no subordination as long as corporate plan is

i. adopted

ii. pursued in good faith

iii. in accordance with state laws

Where controlling SH has used corporation as a corporate pocket and has treated its affairs as his own, loans/advances by the controlling SH will be subordinated to claims of other creditors

Pre-emptive Rights
1. Enable SHs to maintain proportionate ownership in corporation when company sells new issues of stock
2. Purpose

i. to prevent ownership interests from being diluted

ii. to prevent dilution of proportionate voting control

Important in closely held corporations
THREE APPROACHES –

i. Preemptive rights are mandatory

ii. are granted unless the corporate charter provides to the contrart (opt out provisions)

iii. are granted only if corporate charter elects them (opt in provisions)

Preemptive rights & MBCA § 6.30

i. Opt-in approach (#3 above)

ii. Requires corporate charter to state election of preemptive rights

iii. BUT preemptive rights do not apply to shares

1. issued as compensation

2. used to satisfy a conversion

3. some classes of SHs may not be entitled to preemptive rights under the corporate charter

4. some holders of preferred stock may not have preemptive rights

NEW YORK APPROACH – all SHs must be given equal opportunity to purchase additional shares

Share Transfer Restrictions
1. Restrictions on Alienability in Closed Corporation

i. Absolute prohibition against transfer of shares

ii. Consent constraints = requiring approval of SHs/directors

iii. Limited transfers to classes of people (family, employees, etc.)

iv. Corp/officers/directors/SHS have a right of first refusal

v. Buy-out agreements

vi. Corporate repurchase/redemption of shares

Buyout Agreements
Valuation Issues

IV. Corporate Structure

A. After application to SoS à state will issue a corporate charter

B. Procedures