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©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
CHAPTER 7
Corporations
THEME
Alternative forms of business organizations
were explored in Chapters 2 through 6. Chapter
7 introduces the corporation. The discussion in
Chapter 7 focuses on the definitions and nature
of corporations. This chapter and the rest of the
text focus on business corporations unless oth-
erwise noted.
CHAPTER GOAL
The goal of this chapter is for students to be-
come familiar with the following terms and
topics concerning corporations:
• Corporation
• Corporation characteristics
• Various types of corporations
• Advantages and disadvantages of doing
business as a corporation compared to other
forms of business organization
• The role of corporate paralegals
• Resources available to corporate paralegals
SUGGESTED APPROACH
Many of the discussions in the text regarding
corporations refer to the Model Business Corpo-
ration Act (MBCA), as amended through 2009.
Students should be asked to locate and become
familiar with the Business Corporation Act (or
similar act) in their home state. The current ver-
sion of the MBCA, as well as links to the busi-
ness corporation acts of each state, is available
on the CourseMate website that accompanies
this text at http://www.cengagebrain.com.
Discussing prominent corporations from
the students’ home state is often a good way to
get students interested in the topic of corporate
law.
This chapter also begins an examination
of the role of the corporate paralegal. Students
may be interested in exploring the different
types of careers corporate paralegals may have.
A corporate paralegal guest speaker or a panel
of corporate paralegals with diverse careers may
be of interest to the students at this time.
LECTURE NOTES
An Introduction to Corporations
1. Corporations are artificial entities separate
from their owners that may exist perpetual-
ly and have certain rights and powers exer-
cised through their agents.
2. Because the corporation is a separate enti-
ty, the corporation itself is liable for any
debts and obligations it incurs.
3. Corporate shareholders, directors, and of-
ficers are generally free from personal lia-
bility for the debts and obligations of the
corporation.
4. The corporation’s state of domicile is the
state in which the corporation was incorpo-
rated.
5. Internal affairs of the corporation are gen-
erally governed by state statutes of the cor-
poration’s state of domicile.
6. Corporations are also subject to common
law, case law, federal statutes, and local
ordinances.
7. Most state business corporation acts are
modeled after the Model Business Cor-
poration Act, first published in 1950, or
the 1984 Revised Model Business
Corporation Act. The 1984 Revised
Model Business Corporation Act con-
tinues to be revised periodically.
Corporations in the United States
8. With business receipts of several trillion
dollars each year, large corporations play a
very important role in the economy of the
United States.
9. In 2007, more than half of the households
in the United States owned shares of stock
or mutual funds.
CHAPTER 7 Corporations 49
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
Corporate Rights and Powers
10. Corporations, as artificial persons, are enti-
tled to many of the same rights as natural
persons.
11. The state business corporation act may
enumerate specific powers granted to cor-
porations. In general, state statutes grant a
corporation the right to perpetual duration
and succession in its corporate name and
all the powers of an individual to do all
things necessary or convenient to carry out
the corporation’s business and affairs.
Advantages of Doing Business as a
Corporation
12. Transacting business as a corporation of-
fers many advantages over other types of
business organizations, including the fol-
lowing:
• Corporations provide officers, direc-
tors, and shareholders with limited lia-
bility.
• The corporation has the ability to exist
perpetually. Shares of stock may be
sold or gifted to others without affect-
ing the continuity of the corporation or
its business.
• The centralized management of a cor-
poration may streamline the decision-
making process.
• The ownership interest of a corporation
may be easily transferred.
• Owners of a corporation may be in a
position to take advantage of several
qualified benefit plans.
• The shareholders of a corporation may
choose its tax year.
• Corporations have increased potential
for raising capital.
Disadvantages of Doing Business as a
Corporation
13. Transacting business as a corporation has
its disadvantages as compared to other
types of business organization, including
the following:
• Corporations are one of the most com-
plex types of business organization,
and the formation and operation of
corporations involves more formalities
and reporting requirements than most
other forms of business.
• The double taxation on corporate in-
come, as well as the taxes assessed on-
ly on corporations, can be a serious
disadvantage to transacting business as
a corporation.
Piercing the Corporate Veil
14. Under certain circumstances, the corporate
veil may be pierced and the corporate enti-
ty disregarded. If the corporate veil is
pierced, the corporate shareholders, direc-
tors, or officers may be held personally ac-
countable for the corporation’s obligations.
15. The corporate veil may be pierced when a
corporation is formed or operated to com-
mit fraud or other illegal activity, or to de-
fend a crime.
16. The corporate veil of a small corporation
may be pierced to prevent an inequity, in-
justice, or fraud, especially when the corpo-
rate formalities are not followed and the
corporation is found to be merely an alter
ego of a sole shareholder.
Types and Classifications of Corporations
17. Business corporations are by far the most
common type of corporation in the United
States.
18. Professional corporations are formed only
for the purpose of rendering the services of
a single profession.
19. All shareholders of professional corpora-
tions must be licensed professionals.
20. Nonprofit corporations, or not-for-profit
corporations, are formed only for certain
nonprofit purposes.
21. Certain nonprofit corporations may qualify
to be tax-exempt, but an application must
be made to the Internal Revenue Service
pursuant to IRC § 501(c).
50 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
22. S Corporations are a special type of corpo-
ration formed pursuant to Subchapter S of
the Internal Revenue Code.
23. S Corporations are taxed as partnerships.
24. Shareholders of corporations who wish
partnership taxation status may file an
election to be treated as an S Corporation
with the Internal Revenue Service on
Form 2553.
25. S Corporations must meet several eligibil-
ity requirements. For example, S Corpora-
tions may have no more than 100
shareholders and the corporation may not
issue more than one class of stock.
26. Pass-through taxation has made the S Cor-
poration one of the most popular types of
business organization in the United States.
27. Corporations with a small number of
stockholders and stock that is not publicly
traded are often referred to as closely held
corporations or close corporations. These
corporations are subject to the business
corporation acts of their states of domicile.
28. Many states have adopted special close
corporation statutes that take into consider-
ation the unique characteristics of the
smaller corporation. Qualifying corpora-
tions may elect to be treated under the
close corporation statutes in certain states.
29. Close corporation statutes may provide
for restrictions on the transfer of shares
of close corporations. They may also
provide that close corporations are not
subject to all of the formalities placed on
other corporations.
30. Parent corporations hold stock in their sub-
sidiary corporations sufficient to control
the subsidiaries.
31. The terms sister corporation and affiliate
corporation refer to corporations owned or
controlled by the same owners.
The Paralegal’s Role
32. Corporate paralegals who work for corpo-
rations and for law firms that represent cor-
porations perform a wide variety of tasks.
Resources
33. Resources commonly used by corporate
paralegals include the following:
• State statutes
• Federal statutes
• Secretary of state (or other state corpo-
ration agency) resources
• Online information on corporations
34. The following types of information may be
found online to assist corporate paralegals:
• State corporate statutes
• Federal statutes concerning corporations
• Case law concerning corporations
• General research for corporate law
issues
• General information and treatises
concerning issues in corporate law
• Information concerning filing corporate
documents
• Financial and other information on
publicly held corporations
• Annual reports and other pertinent
documents filed with the Securities and
Exchange Commission
• Forms for forming corporations and
transacting business as a corporation
• Discussions concerning corporate law
• Association information, including
listservs and online discussions for
corporate paralegals
CASE BRIEFS
Hunting v. Elders, 597 S.E.2d 803
(Ct.App.2004)
Purpose: This case is an example of a success-
ful attempt to pierce the corporate veil of a cor-
poration when the corporation is found to be the
alter ego of its owner.
Facts: This case is an appeal by a defendant in
an action that was commenced to recover dam-
ages sustained in an accident caused by a drunk
driver. Catherine Hitchcock, the plaintiff in this
case represented by a guardian ad litem, brought
suit against Chris Gordon, the drunk driver who
CHAPTER 7 Corporations 51
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
caused an accident that left Hitchcock perma-
nently brain damaged, as well as Elmyer Enter-
prises, Inc., the owner and operator of the bar
that served Gordon, and William Elders, share-
holder of Elmyer Enterprises.
In the first portion of the bifurcated trial in this
matter, damages of $1.5 million were awarded
against Gordon and Elmyer Enterprises. The
second phase of the trial, which is the subject of
the appeal, resulted in a holding that Elders was
the alter ego of Elmyer Enterprises, justifying
piercing the corporate veil, thereby holding El-
ders personally liable for the $1.5 million ver-
dict. Evidence presented at trial indicated that
corporate formalities were not followed for
Elmyer Enterprises and that the corporation was
undercapitalized. Testimony by one expert wit-
ness, a forensic accountant, indicated that Elders
siphoned off between $400,000 and $800,000
from the business over a three-year period. Tes-
timony by another expert witness indicated that
Elmyer Enterprises had income that was unac-
counted for and profit that was not adequately
revealed. He further testified that, in his opinion,
Elders was the alter ego of Elmyer Enterprises.
Issue: Should the corporate veil be pierced be-
cause corporate formalities were disregarded by
the defendant/appellant and because the defend-
ant apparently siphoned money from the corpo-
ration, which was undercapitalized?
Holding: Yes
Reasoning: “If any general rule can be laid
down, it is that a corporation will be looked up-
poration as an association of persons….”
In this case, the court used a two-
pronged test (Sturkie v. Sifly, 313 S.E.2d 316,
318 [Ct. App. 1984]) to justify piercing the cor-
porate veil and finding defendant/appellant El-
ders personally liable for the debt of Elmyer En-
terprises. The first part of the test considers
whether corporate formalities were observed by
the dominant corporate shareholders. In this
case, the court found they were not. The second
prong of the test requires “that there be an ele-
ment of injustice or fundamental unfairness if
the acts of the corporation be not regarded as the
acts of the individuals” (Sturkie). In this case,
the court found that Elders knew of the plain-
tiff’s claim against the corporation and that he
nevertheless acted in a self-serving and unfair
manner by siphoning off substantial sums of
money, commingling and transferring assets to
different entities, transferring stock in the corpo-
ration to other individuals, and then finally dis-
solving the corporation. The court further found
that “the essence of the fairness test is simply
that an individual businessman cannot be al-
lowed to hide from the normal consequences of
carefree entrepreneuring by doing so through a
corporate shell.” The court found that Elders’s
actions satisfied the second prong of the test for
piercing the corporate veil and found Elders to
be the alter ego of Elmyer Enterprises and per-
sonally liable for that corporation’s obligation to
the plaintiff.
REVIEW QUESTIONS
1. What are four characteristics of a corpora-
tion that distinguish it from the sole propri-
etorship and the partnership?
1. The corporation is an artificial entity
created by law.
2. The corporation is an entity separate
from its owners or managers.
2. If a corporation defaults on its debts, may
the creditors typically look to the share-
holders for payment?
No
Under what circumstances might the
shareholders become personally liable for
the debts of the corporation?
52 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
3. Suppose that John’s Appliance, Inc. is a
corporation formed by John Miller. John
Miller is the only owner and employee of
John’s Appliance, Inc., an appliance repair
the corporation to shelter his personal as-
sets. He has put title to the repair truck
(which he often uses for his own personal
enjoyment), all of his equipment and tools,
and his workshop in his own name, alt-
hough he leases these items back to the
corporation. What are some of the potential
problems with this arrangement?
the corporate veil.
What can John Miller do to decrease the
risk that the corporate veil of John’s Appli-
ances, Inc. could be pierced in the event of
2. He should be sure to follow all statu-
3. He should be sure to put himself
4. Dave Breen and Sue Martin would like to
start a business involving themselves and
D&S Equipment, Inc., a corporation that
holds certain of their assets. Could they
form a regular business corporation with
Yes
5. Who elects the directors of a corporation?
Who elects the officers?
Could an individual be a shareholder, di-
rector, and officer all at the same time?
6. Could a group of attorneys and physicians
form a single professional corporation?
Why or why not?
7. Are all corporations incorporated as non-
profit corporations automatically exempt
from paying income tax?
No, nonprofit corporations must meet
poration.
rations and regular business corpora-
tions is that the shareholders of S
9. What are some of the practical differences
between regular business corporations and
statutory close corporations?
1. There is a limit on the number of
CHAPTER 7 Corporations 53
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
2. There may be statutory restrictions
3. In many instances statutory close
4. Statutory close corporations often
10. Suppose that Anna and Grace want to start
a business to market a new food product
they have invented. Limited liability is im-
portant to them because of the potential
product liability problems associated with
manufacturing and selling food products.
Initially, Anna and Grace will be the only
investors, and they may not see a profit in
their business for a few years. What types
of business organizations are available to
Anna and Grace?
Anna and Grace would not consider a
partnership or limited partnership if
they are the only investors and they are
both concerned with limiting their per-
What type of organization would you sug-
gest? Why?
A limited liability company or S Corpo-
ration may be the most advantageous
form of business organization, because
SUGGESTED ANSWERS TO
PRACTICAL PROBLEMS
The Practical Problems in this chapter ask stu-
dents to research the business corporation act of
their home state and answer some basic ques-
become familiar with it. The second Practical
home state.
Problems are the state statutes of each student’s
home state (see text, Exhibit 7-8). Links to the
state business corporation acts can be found on
the CourseMate website that accompanies this
text at http://www.cengagebrain.com.
EXERCISE IN CRITICAL THINKING
The Exercise in Critical Thinking for this chap-
ter asks students to contemplate the rights of
corporations in the United States and how those
rights differ (or should differ) from those of in-
dividuals.
Exercise:
As briefly discussed in Section
7.3 of this chapter, there is a
continuing debate in the United
you see as the pros and cons to
granting corporations the
constitutional right to free
speech as the court has done in
Citizens United v. Federal Elec-
tion Commission (2010)?
chapter, and also because S Corporations are
very common, the exercise in this chapter asks
students to elect S Corporation status for their
fictitious corporation, Cutting Edge Computer
Repair, Inc. Students will need to create some of
54 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
the missing information for this exercise (such
as certain dates and telephone numbers). You
may ask them to assume that the corporation has
applied for an employer identification number
and that the corporation was incorporated on the
first day of the previous month.
Form 2553 may be downloaded from
the IRS’s website at http://www.irs.gov. Appen-
dix H is an example of a completed Form 2553,
along with a sample cover letter filing the form.
