The statutory template that most states follow in developing their corporate law statutes is the Model Business Corporation Act, often referred to as the Model Corporation Act and sometimes simply as the MBCA. The MBCA is a relatively young statute, in existence for only about 40 years, and is therefore not quite as settled as older, more traditional statutes, such as the Uniform Commercial Code and the original Uniform Partnership Act.
Today one of the most attractive features of the corporate way of doing business is its limited liability. Limited liability means that the corporate investors cannot be held personally liable for the debts of the corporation. Thus, the most that an investor can lose is the amount of money used to purchase his or her shares of the corporation.
Background Information In the Roman Empire, corporations were recognized as entities with legal identities separate from those of their individual members. As business organizations grew more powerful, the Roman government created mandates to control and tax these early corporations.
Dividends are the net profits, or surplus, set aside for the shareholders. Shareholders (or stockholders, as they are also known) are the persons who own units of interest (shares of stock) in a corporation.
Large private corporations generally sell their stock to the public at large and are therefore often referred to as public corporations. When the owners of a private corporation decide to sell stock to the public at large, financial experts report that the corporation is about to “go public.”
In most instances, they are public utilities, which provide the public with such essentials as water, gas, and electricity. (Note: Unless specified otherwise, the discussion in this chapter and those that follow will focus on private corporations.)
Getting Students Involved Have students look through issues of The Wall Street Journal, Fortune, BusinessWeek, and other business-related publications and check the Internet for stories about the efforts of states to attract corporations. American Airlines, Sears, Saturn, and BMW are examples of corporations that have negotiated favorable arrangements with various states. Ask students to report on their findings in class.
Teaching Tips Certification of authority is obtained by filling out an application, along with other required documents, and submitting them to the secretary of state. It is important for the applying corporation to consult the secretary of state to ensure that all statutes are being followed.
State business corporation statutes generally accommodate closely held corporations by allowing them to have a few directors or a sole director and president, with no voting shares in the hands of the public.
In this way, they avoid double taxation. There are, however, several restrictions on S corporations. These restrictions include limits on the number and types of owners that can be involved in such an entity. Consequently, many individuals now look to limited liability companies to escape double taxation.
In addition, LLCs are statutory, which means that they may come into existence only if the owners follow the precise steps laid out in the state code by the state legislature. The owners of an LLC are called members. The people who run the LLC are called managers. Later in this chapter, we discuss the formation details of an LLC. Chapter 39 also includes a discussion of the duties and responsibilities of the members and the managers of an LLC.
Background Information Any transactions by the promoter on behalf of the corporation before incorporation are considered to be pre-incorporation transactions. These transactions must be ratified by the corporation after it is formed if they are to be valid and binding on the corporation.
The promoter may also include an automatic release clause in all contracts negotiated for the unborn corporation. However, the release clause must do more than simply include the corporation as a party to the contract. It must also specifically release the promoters from liability.
Some state incorporation statutes are very strict, requiring detailed information in the articles of incorporation. Typically this information includes the following: • The corporation’s name • The duration of the corporation • The purpose(s) of the corporation • The number and classes of shares • The shareholders’ rights in relation to shares, classes of shares, and special shares • The shareholders’ right to buy new shares • The addresses of its original registered (statutory) office and its original registered (statutory) agent • The number of directors plus the names and addresses of the initial directors • Each incorporator’s name and address
Background Information A corporation’s certificate of incorporation may be changed; however, it costs time and money to do so. With variations from state to state, parts of the certificate that can be changed include the corporate name, corporate purpose, and office address. Also, the duration of the corporation can be extended or renewed, and the number of shares can be increased or decreased
Nevertheless, the first order of business at an incorporator-run meeting is to elect the directors. In addition to the appointment of the first directors, the adoption of bylaws, or regulations, also occurs at the organizational meeting.
If neither the articles nor the operating agreement, as discussed below, include a duration statement, then some state statutes set an automatic duration period, generally of 30 years. In contrast, in the absence of a duration statement, other state statutes set an unlimited duration. The name of the LLC must include the term “Limited Liability Company” or those words abbreviated, followed by the word “Limited” or the abbreviation “Ltd.” In addition, the name of the LLC must not be the same as the name of another LLC or corporation.
Typically includes formation provisions, operating provisions, the nature of the business to be conducted by the LLC, distribution of profits and losses, the powers of the managers, voting rights of the members, admission and withdrawal procedures, provisions regarding the transfer of a member’s interest in the LLC, and provisions involving the termination of the LLC, among others
A corporation whose existence is the result of the incorporators having fully or substantially complied with the relevant corporation statutes is a de jure corporation. Its status as a corporation cannot be challenged by private citizens or the state.
Usually, if only some minor requirement has been left unsatisfied, the court will hold that there has been a good faith attempt to incorporate. Only the state can directly challenge the existence of a de facto corporation. Thus, a de facto corporation has the same rights, privileges, and duties as a de jure corporation as far as anyone other than the state is concerned.
Corporation by estoppel does not create a real corporation. Instead, it is a legal fiction used by the courts on a case-by-case basis to prevent injustice. Generally, but not always, it is applied in contract cases rather than in tort cases.
The shareholders of close corporations are more likely to fall victim to piercing the corporate veil than are the shareholders of large corporations, because the shareholders of a close corporation are often also the original incorporators, as well as the directors and officers of the corporation, and thus may neglect to follow the corporate formalities required by statute and/or fail to keep corporate property and business separate from their personal property and business. Thus, the court will sometimes find that the corporation is nothing more than the alter ego (other self) of the original incorporators.
Getting Students Involved Have students obtain the annual reports of three or four corporations. Annual reports are available at most public libraries, on the Internet, or directly from local corporations. Ask students to analyze the reports and select companies for investment. Have students explain the rationale for their choices.
A corporation’s board of directors has the sole authority to determine the amount, time, place, and manner of dividend payment. Typically, the directors’ declaration of a dividend sets a cutoff date—the date by which a shareholder must hold corporate stock of record to receive payment.
The correct answer is “C” – stock certificate. See next slide.
The correct answer is “B” – novation. See next slide.
The correct answer is “D” – bylaws. See next slide.
The correct answer is “A” – Certificate of authority . See next slide.
The correct answer is “B” – public. See next slide.
The correct answer is “C” – corporation. See next slide.
The Corporate Entity
1. Describe the evolution of associative
2. Explain the nature of a corporation.
3. List the constitutional rights of a corporation.
4. Describe the differences among a private, a public,
and a quasi-public corporation.
5. Distinguish between a close and an S corporation.
Learning Objectives (cont.)
6. List the typical elements within the articles of
7. Distinguish between the articles of organization
and the operating agreement of a limited liability
8. Distinguish between a de jure and a de facto
9. Identify the objective of piercing the corporate veil.
10. Distinguish between common and preferred stock.
The Theory of Corporativism
– a legal entity created under the authority of a
state or federal statute that gives certain
individuals the capacity to operate an enterprise.
– The process of doing business as a selfgoverning business association, or corporation
Corporate Limited Liability
• Limited liability
– the corporate investors cannot be held personally
liable for the debts of the corporation.
Corporate Entity Status
• A corporation exists apart from its owners
and is taxed directly on the income it
• As a legal entity, a corporation can own
property and sue or be sued,
Types of Corporate Entities
• Private corporation
– a corporation formed by private persons to
accomplish a task best undertaken by an entity
that can raise large amounts of capital quickly or
that can grant the protection of limited liability.
Types of Corporate Entities
• Public corporation
– a corporation created by the federal, state, or
local government for governmental purposes.
Types of Corporate Entities
• Quasi-public corporations
– Corporations that are privately organized for profit
but also provide a service on which the public
Domestic, Foreign, and Alien
• A corporation is a
corporation in the
state that grants its
• It is a foreign
corporation in all
• Alien corporation
– one that, though
incorporated in a
foreign country, is
doing business in the
Domestic, Foreign, and Alien
• Certificate of authority
– a document that grants a foreign corporation
permission to do business in another state
Close and S Corporations
• Close corporation
– the outstanding shares of stock and managerial
control are closely held by fewer than 50
shareholders (often members of the same family)
or by one person.
Close and S Corporations
• S corporation
– a corporation in which shareholders have agreed
to have the profits (or losses) of the corporation
taxed directly to them rather than to the
Limited Liability Companies
• Limited liability company (LLC),
– cross between a partnership and a corporation.
– offers the protection of limited liability to its
– tax liability flows through the LLC and to the
– escapes the double taxation penalty that falls on
Steps in the Incorporation Process
– The people who want to begin a new corporation
or incorporate an existing business
– the people who actually sign the articles of
incorporation and submit them to the appropriate
– The agreement releasing a promoter from
Articles of Incorporation
• Articles of incorporation
– the written applications to the state for permission
– prepared by the corporation’s incorporators
– represent the legal boundaries within which a
corporation must conduct its business
Approval of Articles
• Statutory agent
– an individual who is designated to receive service
of process when a lawsuit is filed against the
• Certificate of incorporation
– the corporation’s official authorization to do
business in the state
Commencement of the Business
– the rules that guide the corporation’s day-to-day
– usually stipulate the time and place of
shareholders’ and directors’ meetings, quorum
requirements, qualifications and duties of
directors and officers, and procedures for filling
The Articles of Organization
• Articles of organization
– the written application to the state for permission
to form a limited liability company
The Operating Agreement
• The operating agreement
– Typically includes formation provisions, operating
provisions, the nature of the business to be
conducted by the LLC, distribution of profits and
losses, the powers of the managers, voting rights
of the members, etc.
• De jure corporation
– one that has been formed properly by
incorporators who followed all of the steps
outlined by the state incorporation statute.
• A de facto corporation exist when:
– A valid state incorporation statute must be in
– The parties must have made a bona fide (good
faith) attempt to follow the statute’s
requirements for incorporation.
– The business must have acted as if it were a
Corporation by Estoppel
• Corporation by estoppel.
– if a group of people act as if they are a
corporation when they are not, any parties who
have accepted that counterfeit corporation’s
existence will not be allowed to deny that
– individuals who acted as if they were a
corporation will not be able to deny that the
Piercing the Corporate Veil
• Piercing the corporate veil
– a court holds wrongdoers (usually the controlling
shareholders) personally liable for activities
committed in the corporation’s name
• Stock certificate
– written evidence of ownership of a unit of interest
in the corporation
• Cash dividend
– declared and paid out of current corporate
earnings or accumulated surplus at regular
• Stock dividend.
– a distribution of earnings is made in shares of
A __________ is written evidence of
ownership of a unit of interest in the
C. Stock certificate
D. Share credential
What agreement releases a promoter from
A. Certificate of authenticity
D. Disclaimer notification
What are the rules that guide the
corporation’s day-to-day internal affairs?
A. Company handbook
B. Operating agreement
C. Commission agreement
What document grants a foreign corporation
permission to do business in another state?
A. Certificate of authority
B. Certificate of influence
C. Certificate of authenticity
D. Certificate of power
A ________ corporation is created by the
federal, state, or local government for
What legal entity gives certain individuals
the capacity to operate an enterprise?