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Chapter 41 - History and Nature of Corporations
CHAPTER 41
HISTORY AND NATURE OF CORPORATIONS
I. OBJECTIVES
This chapter is intended to introduce students to the nature of corporations. Students should:
A. Understand the history of corporation law.
B. Know the characteristics of corporations.
C. Appreciate how corporations are regulated by the states in which they are incorporated and
the states with which they have contacts.
D. Know when the distinction between a corporation and its shareholders will be recognized by
the law.
E. Learn how to use a parent-subsidiary structure to isolate the liability of risky ventures and to
protect the assets of a business.
II. ANSWER TO INTRODUCTORY PROBLEM
A. No. Gifts&Awards.com is not transacting intrastate business in Arizona. It is merely doing
interstate business between itself in California and its customers in Arizona. Soliciting orders
over the Internet from customers in Arizona is not doing business in Arizona.
B. No. By having neither property nor agents in Arizona, Gifts&Awards.com does not have a
substantial connection with Arizona justifying the imposition of an income tax.
C. No, although states are trying to get legislation to permit taxation of these interstate sales.
Gifts&Awards.com does not have a physical presence in Arizona, which the Supreme Court
has required for a state to impose its sales tax.
D. Yes. Gifts&Awards.com’s connection with Arizona provides the “certain minimum contacts”
that the International Shoe case requires to make Arizona’s assertion of jurisdiction over
Gifts&Awards.com not offend “traditional notions of fair play and substantial justice.” It is
not unduly burdensome for Gifts&Awards.com to be haled into Arizona’s courts when the
subject of the litigation is the quality of goods that Gifts&Awards.com has sold to Arizona
citizens. Therefore, the actions arise out of or are related to Gifts&Awards.com’s contacts
with Arizona. Gifts&Awards.com voluntarily reaches into Arizona with its website to solicit
and sell to Arizona consumers. Thus Gifts&Awards.com is on fair notice that it could be sued
in Arizona. This answer means that Gifts&Awards.com is encouraged to have a liberal return
policy. Rather than face expensive litigation in remote states, it is cheaper for
Gifts&Awards.com to permit consumers to return merchandise with no questions asked. This
is one reason that the larger mail, phone, and Internet order businesses like amazon.com and
Land’s End have liberal return policies. Such a policy can also result in more sales from
consumers who view mail order sales as riskless, even though in fact few consumers take
advantage of the return policy.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 41 - History and Nature of Corporations
III. SUGGESTIONS FOR LECTURE PREPARATION
A. History of Corporations. Briefly review the history of corporations, especially mentioning its
role in facilitating the economic development of modern capitalist nations.
B. Characteristics of Corporations. Review the characteristics of corporations (Figure 1 on page
1072) and compare corporations with sole proprietorships, general partnerships, limited
liability partnerships, limited partnerships, limited liability limited partnerships, and limited
liability companies. The material on forms of business in Chapter 37 will be helpful.
Example: Problem #1.
C. Classifications of Corporations. Briefly define the various kinds of corporations. Note that
most corporations are closely held for-profit corporations.
D. Regulation of Domestic Corporations. Note that most corporations are created under state
law. It is the state of incorporation, therefore, that has primary jurisdiction over what a
corporation may do. Note that about 40% of corporations listed on the New York Stock
Exchange are incorporated in Delaware, because of its liberal corporation statute, low
incorporation fees, and highly experienced and competent judiciary for dealing with intra-
corporate disputes.
Log On (p. 1073): At the first URL, students can view the Model Business Corporation Act.
At the second URL, students can find the corporation law that applies in states of interest to
them.
Note that nonprofit corporations are also regulated by the states. The nonprofit corporation
has become a more important form of business, used by trade organizations, lobbying groups,
consumer cooperatives, community arts councils, and charitable organizations. We cover the
regulation of nonprofit corporations throughout the corporation chapters.
E. The Global Business Environment (p. 1073): Note that there is nothing unique about
American law recognizing the corporate form. The names may be different, but most of the
essential characteristics of corporations are shared worldwide.
F. Regulation of Foreign and Alien Corporations. States other than the one in which a
corporation is organized may regulate a corporation’s activity, if the corporation has sufficient
contacts with those states. Describe the four areas (listed on page 1074 and explained on
pages 1074-1079) in which a state may attempt to assert jurisdiction over a foreign
corporation.
1. Subjecting foreign and alien corporations to suit
a. Note that virtually any contact with a state by a foreign or alien corporation will
justify that state’s courts' asserting jurisdiction over the corporation in respect to
matters arising out of the contact with the state.
b. You may have your students read the Daimler case in Chapter 2, which is
summarized in this chapter at page 1075.
c. Additional Examples: Problem Cases ## 2 and 3.
d. Additional Example: Ryan v. Cerullo (p. 1078): See below.
2. Taxation of Foreign Corporations. Explain the basis for permitting a state to tax a foreign
corporation: a corporation enjoys the protection of a state’s laws; it should be required to
pay for that protection through taxation. Examples:
a. Road use taxes.
b. Property taxes.
c. Income, sales, and excise taxes.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 41 - History and Nature of Corporations
1) You may want to mention here that many states claim that foreign
corporations selling to residents of the states are obligated to collect sales tax for
the states. This applies even to catalog companies, such as Lands End. Note that
the Supreme Court has given the definitive law on this area, the Quill case
mentioned on page 1075.
2) Ethics in Action (p. 1076): This box summarizes the two opposing views on
the legality or constitutionality of state attempts to impose a sales tax on
activities that are primarily interstate transactions when the seller uses affiliates
in the taxing state.
The main objective of this ethics box is to consider the ethics of a state’s
attempts to tax what are primarily interstate transactions. The questions in the
last paragraph frame the issues. You should be able to pick questions from that
paragraph that will encourage vigorous discussion in class.
3) Example: Problem Cases ## 4 and 5.
3. Qualification of Foreign Corporations
a. Define doing business for purposes of qualification. Note that doing business
requires the conduct of intrastate business in the state.
b. Explain the isolated transaction exemption of MBCA Section 15.01(b)(10). Under
this exemption, a corporation may do business in the state, yet not be required to
qualify, because it seldom has such contacts with the state.
Ryan v. Cerullo (p. 1078). The court addresses two issues: whether Cerullo & Co.
was required to qualify to do business in Connecticut, and whether Connecticut’s
courts had jurisdiction over Cerullo with regard to Ryan’s claim against Cerullo. The
court answered no to both questions.
Points for Discussion: Ask your students why Cerullo & Co. was not doing business
in Connecticut for the purpose of being required to qualify to do business. Cerullo
derived only minimal income from Connecticut residents, did not solicit business in
Connecticut, did not promote itself as a national accounting firm, performed the
services for Ryan exclusively in New York, met with Ryan only in New York, and
corresponded only with the New York tax office. The court also held that Ryan’s
residence in Connecticut and Cerullo’s preparing Ryan’s Connecticut tax return were
insufficient contacts to constitute the transaction of business in the state.
Additional Points for Discussion: Note that the court correctly pointed out that the
contacts justifying jurisdiction over a corporation are less than those required for
qualification. The court didn’t really address that issue very well, or at least didn’t
support it well with facts. Nonetheless, the second requirement for Connecticut
having jurisdiction over Cerullo & Co. was addressed fully: Ryan’s claim did not
arise out of any business conducted by Cerullo & Co. in Connecticut. Why?
Because of the points already made regarding qualification and because Ryan is suing
regarding Cerullo’s preparation of New York tax returns, not Connecticut returns.
Additional Examples:
1) Problem Cases ## 6 and 7.
2) Would the NCAA’s sanctioning of a national track meet at Drake University (the
Drake Relays) require the NCAA to qualify in Iowa? No. Would a California
restaurant franchisor that sells the right to use its trademark to a franchisee in
New York be required to qualify in New York? No. Is qualification required if
the franchisor advises the franchisee how to train its employees and run a
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 41 - History and Nature of Corporations
profitable business? No. Is qualification required if the national franchisor
managed the business in New York? Yes.
c. List the penalties for a failure to qualify.
Example: Problem Case # 12. This court refused to hold a corporation’s sole
shareholder liable for the corporation’s debts merely because he failed to qualify to
do business in the foreign state.
d. Log On (p. 1077): Businesses that undertake the burdens of qualifying their clients
have carved a niche for themselves.
4. Regulation of Foreign Corporations’ Internal Affairs
Note the importance of this determination whether a state may regulate the internal
affairs of a foreign corporation. It prevents a pseudoforeign corporation from
circumventing the provisions of the corporation law of a state in which it has its most
significant contacts. It prevents such corporations from shopping around for the
corporation statute that is most lenient.
5. Example: Chapter Introductory Problem (p. 1070): This is a good capstone question on
most of the foreign corporation issues.
G. Piercing the Corporate Veil
1. Note that generally a corporation is an entity separate and distinct from its shareholders.
If the shareholders, however, fail to respect the distinction between themselves and the
corporation and use it for an improper purpose, a court will refuse to find a distinction
between the shareholders and their corporation by piercing the corporate veil.
2. Review the two requirements to pierce the corporate veil: domination and improper use
of the corporation. Note here that alter ego by itself is not enough. Dominating a
corporation only sets the stage for piercing the veil; an improper purpose must be shown
as well.
3. Discuss the various improper uses of a corporation: defrauding creditors by thinly
capitalizing the corporation or by looting corporate assets; circumventing a statute;
evading an existing obligation.
a. Thin capitalization, looting, and otherwise defrauding creditors
Examples:
1) Examples in Figure 2 on page 1085.
2) Looting Examples: Problem Cases ## 11 and 13.
3) Thin Capitalization Example: Problem Case # 8.
4) Defrauding Creditors Example: Problem Case # 12.
b. Circumventing a statute
Example: Problem Case # 9.
c. Evading an existing obligation
Examples: Problem Case # 11.
4. Using a parent-subsidiary structure
a. Example: Fran divides her toy manufacturing business into three parts and
incorporates each part separately. She is the sole owner and manager of each
corporation. Corporation One buys material needed to manufacture toys, warehouses
them, and sells them to Corporation Two at market value. Corporation Two
manufactures the toys from the materials and sells the toys to retailers. Corporation
Three finances retailers’ purchases of toys from Corporation Two. Each corporation
has its own books of account. Each corporation pays its own employees. If
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 41 - History and Nature of Corporations
Corporation One fails to pay its creditors, those creditors will not be able to pierce
the veils of the other corporations and make them liable for the debts of Corporation
One. Not only have all the corporations been treated as separate entities, but also
there is no improper purpose.
b. Ethics in Action (p. 1086): This box raises ethics questions about setting up a parent-
subsidiary structure. Note the reasons for the structure: to isolate liability in one or
more subsidiaries so that if one fails the entire business is not lost. The holding
company is used to overcome disadvantages otherwise caused by having several
subsidiaries: to provide for efficient management by the holding company and to
reduce the cost of raising capital.
Any profit maximizer would set up a parent-subsidiary structure like this. It is legal
and it helps to maximize the value of the total business by protecting most of the
enterprises assets when one part of the business fails.
As for the creditor of a subsidiary who is unable to attack the assets of the parent or
other subsidiaries, it is reasonable to expect a contract creditor to know his debtor
before extending credit to it. Thus, a contract creditor should check out a
subsidiary’s financial position before dealing with it. That rationale fails, however, if
the contract creditor is a consumer who buys a product from the subsidiary. In such a
context, the consumer doesn’t have a real opportunity to check out his creditor. That
rationale also fails if the creditor is a tort creditor. It is not usual for a tort creditor to
check out a defendant before the defendant commits a tort.
c. Additional Example: Problem #10.
5. Supply Chain Assocs., LLC v. ACT Elecs., Inc. (p. 1081). This is a daunting case with
facts that have confusingly similarly named businesses and a long list of factors the court
considers, some discussed with more than minimal detail. The bottom line is that the
defendants were granted summary judgment because the defendant showed that the
corporate veils of the corporations should not be pierced as a matter of law.
Points for Discussion: You could devote a lot of class time to going through each of the
12 factors the court considered to determine whether to pierce the veils. Instead ask your
students which factors are the most important ones. Or maybe the better question is
which ones are not very important. The least important factor is the lack of paying
dividends. Even the court provides a convenient out when dividends are not paid, that is,
that the corporation has consciously decided not to pay dividends. Lots of corporations,
public and nonpublic, don’t pay dividends, and they all have reasons, in fact typically
good reasons, not to do so.
Another less important factor is the insolvency of the corporation at the time of the
transaction. While usually veil-piercing cases arise because a company is insolvent,
insolvency can occur for a number of reasons that will not justify a veil piercing. It really
is not a factor at all. What is important is why the company does not pay its debts.
Additional Points for Discussion: So what are those important reasons? They include
pervasive control, thin capitalization, siphoning away assets, and promoting fraud. Note
how these factors, as well as others in the case, fit neatly under the textbook’s structure
for determining when to pierce the veil: 1) domination and 2) use of that domination for
an improper purpose. Have the students categorize each factor in this case under one of
those two factors. Be sure they understand that factors proving alter ego--such as
confused intermingling of assets, nonobservance of corporate formalities, absence of
corporate records, and non-functioning officers and directors--logically go under
domination. Other factors—such as thin capitalization and promoting fraud go under
improper purpose.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 41 - History and Nature of Corporations
IV. RECOMMENDED REFERENCES
A. Cox & Hazen, The Law of Corporations (3rd ed. 2010). A three-volume treatise on
corporation law by leading experts in the field.
B. Eisenberg & Cox, Corporations and Other Business Organizations (10th ed. 2013).
C. Haas, Corporate Finance in a Nutshell (2nd ed., 2011).
D. Hamilton & Freer, Law of Corporations in a Nutshell (6th ed. 2010).
E. In Defense of the Corporation (Hessen, ed. 1979).
F. Model Business Corporation Act Annotated. Published by Law & Business Inc./Harcourt
Brace Janovich.
G. Nader, Green, & Seligman, Taming the Giant Corporation (1976).
H. Stone, Where the Law Ends (1975).
I. The Business Lawyer. The journal of the ABA Section of Business Law.
J. The Journal of Corporation Law. Published by the University of Iowa School of Law.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
