Chapter 42 – Organization and Financial Structure of Corporations
-
date post
21-Oct-2014 -
Category
Education
-
view
2.069 -
download
0
description
Transcript of Chapter 42 – Organization and Financial Structure of Corporations
42-1
Organization and Financial Structure of
Corporations
PA ET RHC 42
Our business is company creation.
Ann Winblad, venture capitalist, quoted in Fortune magazine (Sellen and Daniels, Oct. 1999)
42-2
Learning Objectives
• Appreciate the risk of liability for corporate promoters
• Understand the process for incorporating a business
• Know the appropriate sources for financing a business
• Explain share-transfer restrictions
42-3
• Each state has enacted laws detailing how a corporation may be created
• A promoter of a corporation incorporates the business, organizes initial management team, and raises initial capital
• A promoter may be the person who originated the idea for the firm or may be a professional hired to undertake incorporation activities
Overview
42-4
• A promoter will be liable for contracts made during the preincorporation period unless the corporation adopts the contracts made by the promoter (adoption) and the third party agrees to substitute the corporation for the promoter (novation)– Like agency ratification, may be express or
implied– Contracts adopted typically: employment
and real property lease or purchase
Preincorporation Contracts
42-5
• Facts:– SmithStearn Yachts, Inc., (Smithstearn) a
Delaware corporation providing luxury yachting services in Connecticut, agreed to a contract with Gyrographic Communications, Inc., a California company, for marketing and promotional services to SmithStearn
– SmithStearn sued Gyrographic, which argued that it had made a contract with SmithStearn Yachts, LLC, not a corporation
SmithStearn Yachts, Inc. v. Gyrographic Comm., Inc.
42-6
• Legal Analysis & Holding:– A corporation generally is not bound by
contracts entered into on its behalf prior to its existence, but it can acquire rights and subject itself to duties for preincorporation matters
– SmithStearn Yachts, Inc. was formed after execution of the agreement, but received benefit of the services pursuant to the agreement and thus ratified the contract
SmithStearn Yachts, Inc. v. Gyrographic Comm., Inc.
42-7
• Legal Analysis & Holding:– Gyrographic developedg letterheads, business
cards, and other marketing material for SmithStearn Yachts, Inc., and SmithStearn Yachts, Inc. made payments to Gyrographic
– SmithStearn Yachts, Inc. is a proper party
SmithStearn Yachts, Inc. v. Gyrographic Comm., Inc.
42-8
• Preincorporation share subscriptions are contracts in which a prospective shareholder offers to buy a specific number of shares in a new corporation at a stated price
• Under the Model Business Corporation Act (MBCA), a prospective shareholder may not revoke a preincorporation subscription for a six-month period
Share Subscriptions
42-9
• A promoter is not an agent of the proposed corporation or investors since they did not appoint the promoter, but a promoter owes a fiduciary duty to the corporation and to its prospective investors– No self-dealing, duty of loyalty, etc.
• A corporation may compensate a promoter with shares
Promoter Duties
42-10
• A U.S. business may incorporate in any state• Fees, taxes, and laws vary from state to state
– See, e.g., Texas corporations section:• www.sos.state.tx.us/corp/index.shtml
Incorporation
Stock Certificate of a Texas
Corporation
42-11
1. Prepare articles of incorporation2. Sign and authenticate articles by one or
more incorporators3. File articles with secretary of state, pay
fees4. Receive copy of articles of incorporation
stamped “Filed” by secretary of state, along with fee receipt
5. Hold organizational meeting for purpose of adopting bylaws, electing officers, and transacting other business
Steps in Incorporation
42-12
• The articles of incorporation (or charter) is the basic document stating the rights and responsibilities of a corporation, its management, and its shareholders– Must add extension to name indicating
corporate form: Inc., Corp., Co., Ltd.– Must include other specifics, such as number of
shares authorized, initial registered office and agent’s name, name and address of each incorporator
– See Fig. 1
Incorporation Details
42-13
• Other provisions (not inconsistent with law) may be added to articles of incorporation or included within corporate bylaws– See Fig. 2
• To retain corporate status, a corporation must file an annual report with secretary of state of the state of incorporation and pay an annual franchise fee or tax
Incorporation Details
42-14
• Sometimes, an attempt to incorporate fails
– One consequence is that the corporate shield does not exist to protect shareholders, officers, and directors from personal liability
– Another possibility is that a party to a contract involving a defective corporation may claim nonexistence of the corporation to avoid a contract made in the name of the corporation
Defective Incorporation
42-15
• De jure corporation: exists when promoters and incorporators substantially comply with each mandatory (shall, must) requirement to incorporate the business
• The validity of a de jure (by law) corporation cannot be attacked except by the state of incorporation due to noncompliance with state corporation laws
De Jure Corporation
42-16
• De facto corporation: exists when promoters fail to comply with all of the mandatory requirements, yet comply with most of the mandatory provisions
• Validity of a de facto corporation could be attacked by a third party, or itself, or the state of incorporation, but may be treated by as a corporation under the judicial doctrine of corporation by estoppel
De Facto Corporation
42-17
• Under the MBCA, filing the articles of incorporation is conclusive proof that the corporation exists
• MBCA imposes joint and several liability for a purported corporation’s contracts and torts on managers and shareholders who both (1) participate in operational decisions of the business and (2) know the corporation does not exist
The MBCA
42-18
Christmas Lumber Co., Inc. v. Valiga
• Facts: – Contractor (Waddell) and Valiga entered home
construction contract, which fell through– Contractor had purchased construction
materials from plaintiff (through Graves) and in 1990, plaintiff filed suit against Valiga and contractor
– 1992: Valiga filed separate suit against Waddell and Graves, claiming defective incorporation
– Suits consolidated; trial court found Waddell and Graves liable as partners to Valiga
42-19
• Legal Reasoning & Holding: – Waddell said he didn’t know incorporation failed– Evidence: Waddell testified he and Graves were
“partners,” the two entered a joint venture agreement, and they shared contractor’s fee
– Conclusion: Waddell and Graves were partners– Judgment for Valiga affirmed
Christmas Lumber Co., Inc. v. Valiga
42-20
• A non-profit corporation incorporates in same way as a profit corporation, but must declare whether it is a: – public benefit corporation, mutual
benefit corporation, or religious corporation
• Nonprofit corporation’s articles must also state whether it will have members
Non-Profit Incorporation
42-21
• For-profit corporations are financed by:– Sale of securities: shares, debentures,
bonds, and long-term notes payable– Short-term financing (e.g., inventory
financing)– Bank loans
Financing Corporations
42-22
• Equity securities, better known as stock or shares, create an ownership relationship, thus stockholders or shareholders own a corporation
• State laws permit corporations to issue classes of shares with specific rights: – Common – Preferred
Equity Securities
42-23
• Claims for dividend payments or asset distribution on liquidation are subordinate to creditor or preferred shareholder claims
• However, common shareholders have the exclusive right to elect corporate directors and exclusive claim to corporate earnings and assets that exceed the claims of creditors and other shareholders
Common Shareholders
42-24
• Preferred shareholders generally receive liquidation and dividend preferences over common shareholders
• A corporation may have several classes of preferred shares with specific rights related to dividend payments, asset distribution upon liquidation, voting, stock redemption, and stock conversion
Preferred Shareholders
42-25
• Authorized shares are shares a corporation is permitted to issue by its articles of incorporation– A corporation may not issue more shares
than authorized
• Issued shares have been sold to shareholders
• Outstanding shares are currently held by shareholders
Share Types
42-26
• A board of directors may issue options for purchasing the corporation’s shares– Issued to top-level managers as an
incentive
• Warrants are options evidenced by certificates
• Rights are short-term certificated options that are usually transferable– Used to give present security holders an
option to subscribe to more shares
Options, Warrants, & Rights
42-27
• Corporations may borrow money to operate by issuing debt securities, such as bonds, debentures, and notes payable
• Debt securities create a debtor–creditor relationship between the corporation and the security holder
Debt Securities
42-28
• Debentures are long-term, unsecured debt securities with a 10 to 30 years term– Having an indenture, or a contract stating the
rights of the debenture holder
• Bonds are long-term, secured debt securities– Identical to debentures except that bonds are
secured by collateral
• Notes generally have less than a five year term and may secured or unsecured
Debt Securities
42-29
• MBCA permits shares to be issued in return for any tangible or intangible property or benefit to the corporation, including cash, promissory notes, contracts for services to be performed for the corporation, services performed for the corporation, and securities of the corporation or another corporation
Consideration for Shares
42-30
• The board must issue shares for an adequate dollar amount of consideration
• Par value is an arbitrary dollar amount that may be assigned to shares by the articles of incorporation– Does not reflect fair market value, but is
the minimum amount of consideration for which the shares may be issued
Consideration for Shares
42-31
• Under the terms of a share subscription, a prospective shareholder promises to buy a specific number of shares at a stated price– Generally in writing, though not required
• A share certificate may not be issued to a share subscriber until the share price has been fully paid
Share Subscriptions
42-32
• Share certificates are registered with the corporation in name of a specific person
• Indorsement of a share certificate on back by the registered owner and delivery of the certificate to another person transfers ownership of the shares
• Under the UCC, a corporation owes a duty to register transfer of any registered shares, provided it has proper indorsement
Transfer of Shares
42-33
• Shares in a publicly held corporation are freely transferable, but often close corporations (less than 50 shareholders) restrict transfer to ensure control
• Four categories of transfer restrictions: (1) rights of first refusal and option agreements, (2) buy-and-sell agreements, (3) consent restraints, and (4) provisions disqualifying purchasers
Transferability & Restrictions
42-34
• Court enforced a poorly drafted buy-sell agreement in which the shareholders were to agree from time to time on the price to be paid for the shares, but failed to do so
Coyle v. Schwartz
42-35
Test Your Knowledge
• True=A, False = B– A promoter is always liable for contracts
made during the preincorporation period.– A U.S. business may incorporate in any
state.– A de facto corporation exists when
promoters and incorporators actually comply with each mandatory requirement to incorporate
– Warrants are stock options evidenced by certificates.
42-36
• True=A, False = B– Preferred shareholders have exclusive
right to elect corporate directors and the exclusive right to dividend payments.
– For-profit corporations are financed only by issuing securities in the form of shares.
– The MBCA permits shares to be issued in return for any tangible or intangible property or benefit to the corporation.
Test Your Knowledge
42-37
• Multiple Choice– Which of the following is not a debt
security: a) Stockb) Bond c) Debentured) Notee) none of the above
Test Your Knowledge
42-38
• Multiple Choice– The Steel Inc. Board of Directors plans
to issue dividends this year. Which of the following is false?
a) Preferred shareholders receive their dividends before common shareholders
b) Creditors receive their dividends before common shareholders
c) Common shareholders receive their dividends before either creditors or preferred shareholders
Test Your Knowledge
42-39
Thought Question
• Do you believe that a company’s stock price reflects a company’s value or success in (a) the marketplace, and (b) society?