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1919Legal Environment 4Legal Environment 4thth Ed. Ed.

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Quote of the DayQuote of the Day

“CORPORATION, n. An ingenious device for obtaining individual profit

without individual responsibility.”Ambrose Bierce, American writer,

“The Devil’s Dictionary”



Incorporation ProcessIncorporation Process The person who organizes a corporation is

called a promoter. The promoter is personally liable on any contract signed before formation.

The corporation is not liable unless it adopts the contract after incorporation. The promoter is no longer liable if the other party agrees to a novation – a new contract.

Where to Incorporate?• In a state –either the home state of the

business or a state which has favorable laws for corporations (often Delaware)



Incorporation ProcessIncorporation Process Charter’s Required Provisions

• Name of corporation• Address and Registered Agent• Incorporator –person who signs the

charter and delivers it to the Secretary of State for filing (perhaps the lawyer or the promoter)

• Purpose –can be a broad statement, such as “to conduct lawful business”

• Stock – number, par value and types (classes and series) offered



StockStock Stock can be:

• Authorized and unissued• Authorized and issued or outstanding• Treasury stock (been issued, then bought

back by company)

Par value - minimum issue price

Classes and series• Owners of preferred stock have preference

on dividends and liquidation.• Common stock is last in line for any corporate

payouts, including dividends and liquidation.



After IncorporationAfter Incorporation

Directors and officers are elected, unless all shareholders agree to not have a board of directors.• Small corporations may elect directors by

written consent.

Minute book holds records of all meetings.

Bylaws set the rules for the corporation.



After Incorporation (cont'd)After Incorporation (cont'd)

Issuing Debt – corporations often need to borrow funds for start-up.• Bonds – long term debt secured by

company assets.• Debentures – long term, unsecured debt.• Notes – short term, either secured or

unsecured.



Death of a CorporationDeath of a Corporation May be voluntary (shareholders’ vote) or

forced (by court order).

Piercing the Corporate Veil -- court may hold shareholders liable for debt in the case of:• Failure to observe formalities (such as holding

meetings, keeping records)• Commingling of assets (using corporate funds to

pay personal debts, etc.)• Inadequate capitalization (the corporation

should obtain insurance against liability for torts)• Fraud (injured party may recover from the guilty

party, even if the action was the corporation’s)



TerminationTermination Terminating a corporation is a three-

step process:• Vote by a majority of the shareholders.• Filing Articles of Dissolution with the

Secretary of State.• Winding up – paying debts and distributing

assets.



Managers vs. Shareholders: The Inherent Conflict

Managers vs. Shareholders: The Inherent Conflict

Managers – want, first to keep their jobs and second, to build a strong company.• Managers have a fiduciary duty to act in the

best interests of the shareholders.

Shareholders – want the price of stock to increase.

Stakeholders – want the business to grow and continue to use the stakeholders’ services.



Resolving the Conflict: The Business Judgment Rule

Resolving the Conflict: The Business Judgment Rule

Business Judgment Rule -- The manager has a duty of loyalty and a duty of care.• The manager must act without a conflict of

interest, with the care of an ordinary prudent person and in the best interests of the company.

This rule allows directors to do their job without fear of excessive court intervention.



Duty of LoyaltyDuty of Loyalty The duty of loyalty prohibits managers

from making a decision that benefits them at the expense of the corporation.

Self-Dealing is a violation of the duty of loyalty.• See next slide for more on self-dealing.

Corporate Opportunity• Managers are in violation of the corporate

opportunity doctrine if they compete against the corporation without its consent.



Self-Dealing Self-Dealing A manager makes decisions that

benefit himself or another company associated with the manager.

Self-dealing transactions may be acceptable if:• The disinterested members of the board of

directors approve the transaction.• The disinterested shareholders approve it.• The transaction was fair to the corporation.



Duty of CareDuty of Care The duty of care requires officers and

directors to act in the best interests of the corporation and to use the same care that an ordinarily prudent person would in the management of her own needs.• Decisions must have a rational business

purpose.• Decisions and actions are legal.• Managers must make informed decisions.



More Conflict: TakeoversMore Conflict: Takeovers There are three ways to acquire control

of a company:• Buy the company’s assets.• Merge with the company.• Buy stock from the shareholders.

Takeovers and tender offers are regulated:• Federal Regulation of Tender Offers: The

Williams Act• State Regulation of Takeovers• Common Law of Takeovers



Prevention of TakeoversPrevention of Takeovers Companies may try to prevent

takeovers in many ways:• Transferring assets, re-distributing stock,

re-structuring the board of directors, etc.• These tactics are sometimes called “shark

repellants”

When establishing takeover defenses, shareholder welfare must be the board’s primary concern.



State Anti-Takeover StatutesState Anti-Takeover Statutes Most states have passed statutes

to deter hostile takeovers:• Statutes that automatically impede

hostile takeovers.• Statutes that authorize companies to

fight off hostile takeovers.



The Role of ShareholdersThe Role of Shareholders Directors, not shareholders, have the

right to manage the corporate business.• Inside directors -- officers in the

corporation, typically control their company’s board.

• Outside directors (also called independent directors) -- do not work for the company and typically have less control.



Rights of ShareholdersRights of Shareholders Shareholders have neither the right nor

the obligation to manage the day-to-day business of the enterprise.

Right to Information • Under the Model Act, shareholders with a

proper purpose have the right to inspect and copy the corporation’s minute book, accounting records, and shareholder lists.

Right to Vote• A corporation must have at least one class

of stock with voting rights.



Shareholder ProposalsShareholder Proposals Under SEC rules, any shareholder who

owns at least 1 percent of the company or $2,000 of stock can require that one proposal be placed in the company’s proxy statement to be voted on at the shareholder meeting.

Only a small percentage of these proposals are passed, but their presence may cause the directors to adopt the proposal’s statement anyway.



Shareholder MeetingsShareholder Meetings

Annual meeting of shareholders are the norm for publicly traded companies.

Companies whose stock is not publicly traded may either hold an annual meeting or use written consent from their shareholders.



Officers and Directors Officers and Directors Election and Removal of Directors

• Shareholders have the right to elect directors and also to remove them from office, though this is a complex and expensive process and is rarely done.

Compensation for Officers and Directors• Typically, directors set their own

compensation (unless the charter or bylaws provide otherwise).



Fundamental Corporate Changes

Fundamental Corporate Changes

A corporation must seek shareholder approval before undergoing any of the following fundamental changes:• Mergers• Sales of Assets• Dissolution• Amendments to the Charter• Amendments to the Bylaws



Right to DissentRight to Dissent

If a corporation decides to undertake a fundamental change, the Model Act and many state laws require the company to buy back the stock of any shareholders who object to this decision.



Right to ProtectionRight to Protection Controlling shareholders have a

fiduciary duty to the minority shareholders.

Minority shareholders have the right to overturn a transaction between the corporation and a controlling shareholder, unless the the transaction is fair to the minority shareholders.



Sarbanes-Oxley ActSarbanes-Oxley Act In response to corporate scandals, Congress passed the

Sarbanes-Oxley Act in 2002.• Requires all publicly-traded companies to adopt effective

financial controls.• CEOs and CFOs must personally certify their company’s

financial statements.• A board’s audit committee must be independent.• No personal loans to directors or officers.• If a company has to restate its earnings, its CEO and CFO

must reimburse the company for any bonus or profits they have received from selling company stock in the past year.

• Each company must disclose if it has an ethics code and, if it does not, why not.

• It is a felony to interfere with a federal fraud investigation.• Whistleblowing employees are protected.• A new Public Accounting Oversight Board has been

established to oversee the auditing of public companies.



Enforcing Shareholder RightsEnforcing Shareholder Rights

Derivative Lawsuits• Brought by shareholders to remedy a

wrong to the corporation. All proceeds of the litigation go to the corporation.

Direct Lawsuits• Shareholders are permitted to sue the

corporation directly only if their own rights have been harmed.



“Entrepreneurs often become impatient with the legal

technicalities required to form and maintain a corporation.

However, these legalities can have a profound impact on the

success of the business.”

“Entrepreneurs often become impatient with the legal

technicalities required to form and maintain a corporation.

However, these legalities can have a profound impact on the

success of the business.”

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COPYRIGHT © 2011 South-Western/Cengage Learning. Click your mouse anywhere on the screen to advance the text in each slide. After the starburst appears,